Inflation Markets: A Portfolio Manager’s Perspective

Stefania A Perrucci

Because general price levels affect asset returns and the economy as a whole, inflation is an important risk that every investor should carefully analyse, and actively manage, in order to protect real wealth. In fact, the rationale for managing inflation risk and for evaluating investments in real return–risk space does not need justification, as it is grounded in common sense. Instead, it might seem surprising that virtually all commonly used investment metrics rely on nominal measures, which do not explicitly capture the insidious impact of inflation on wealth. This cavalier attitude can be in part traced back to inflation-linked instruments (which are explicitly and formulaically indexed to inflation) being a relatively recent innovation to fixed-income markets,¹¹ Refer to Chapters 7 and 20 for a brief history of inflation indexation in developed and emerging countries respectively. combined with the intrinsic difficulty in assessing the correct dynamic relationship between inflation sensitive assets (such as commodities, real estate, equity or infrastructure investments) and inflation itself.

Besides being an important macroeconomic risk, inflation also offers attractive