Europe’s inflation investors sharpen their focus

A distorted inflation picture in Europe since the onset of the sovereign debt crisis last year is boosting interest in country-specific inflation exposure, with more newcomers entering the asset class through alternative investments

Despite the fact that fear of rising inflation due to increasing oil prices and the effect of quantitative easing remains a reality, there are few inflation-linked structured products in existence. One reason for the low issuance level is the combination of very low interest rates and high inflation against a backdrop of tightening funding spreads, which makes institutional investors more eager to hedge using nominal rates as a proxy rather than going for pure inflation hedges, according to Bob Jones, rates structurer at Barclays Capital in London.

“In terms of structured inflation issuance, the main difference from last year is that the pricing is less attractive. The volumes have also declined in general, given the levels of credit risk aversion,” says Jones.

Very low nominal and real yields have also created portfolio allocation shifts among institutional investors into inflation-linked bonds and alternatives rather than them seeking outright inflation exposure to hedge their liabilities or diversify their holdings.

“There’s certainly been a move from a number of different investors in the asset class towards addressing inflation tail risks in the past two years [and] looking at alternatives because of the real yield level and historically low rates,” says Ralph Segreti, inflation-linked and fixed-income index derivatives product manager at Barclays Capital in London. “People seem to be having more discussions around commodities or infrastructure and real assets, and certainly inflation swaps and inflation-linked bonds play a part in this.”

While more emerging markets’ inflation-linked funds are being launched, countries such as Australia are also being used as a proxy hedge. “It’s a triple A economy with a currency people like to have, and we see more money flowing there as well as to emerging markets,” says Segreti.

Inflation-linked exchange-traded funds (ETFs) – in particular, property-linked ETFs – proved popular with investors last year, according to Blackrock’s ETF subsidiary iShares. While inflation-linked ETFs garnered almost $3 billion in flows globally in 2011, flows into property-linked ETFs have almost surpassed last year’s total inflows in the first quarter of this year.

“In terms of property ETF flows, we saw just over $2.2 billion last year and this year there has been similar flows of $2 billion – the equivalent of last year’s flows already,” says Sofia Antropova, investment strategist for Europe, the Middle East and Africa at iShares in London.

Another way to hedge against inflation has been via gold and precious metals. In 2011, $11.6 billion was invested globally in precious metals, with the interest in gold driven by investors’ anticipation of inflation and by very low or even negative real interest rates in some countries. Meanwhile, emerging markets’ equities have benefited from an improved economic outlook since the start of the year, with global flows standing at more than $13 billion in the year to date, says Antropova.

James Norris
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