'Inflation is the Enemy'

MICUK 2021: M&G’s Jim Leaviss says the return of inflation is bad news for bond investors, but there are still opportunities in emerging markets

Holly Black 5 July, 2021 | 10:33AM
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Holly Black: Welcome to the Morningstar Investment Conference 2021. I'm Holly Black. With me is M&G bond investing legend Jim Leaviss. Hello.

Jim Leaviss: Hello.

Black: Welcome to the sofa, we're doing it in the reals.

Leaviss: I know in real life. It's weird.

Black: It is weird.

Leaviss: Stay away.

Black: So you were saying earlier, you've been in the bond world for 29 years. Is it different this time, this year, at the moment?

Leaviss: I think, it could be. I mean, every year, everyone says it's going to be the end of the bond market yields are going up forever. But I think this time, you can make an argument to say, well, what if wages start going up all this fiscal stimulus from Joe Biden throwing money at infrastructure, and central banks that don't seem to care about inflation anymore. If you wanted to come up with a list of the ingredients for inflation to come back, you've got ticks on every single one at the moment, but still, I think the long-term trends make you a bit cautious about that. And as you say 29 years in the market, every year, people have been predicting the end of bonds, and it never turns out to be right.

Black: And you've still got a job. So you're okay. So if inflation comes back, what does that mean for a bond investor?

Leaviss: It's going to be bad news, we have bond yields now, U.S. Treasury bond yields around 1.5%, 10-year gilt yields below 1%. So if inflation hits, even the kind of 2% inflation targets that the Bank of England and the Fed has set, you're going to be losing money from your bond investments. So inflation is definitely the enemy of us bond investors. If it is coming back, then you want to be underweight duration in your funds, you need to be looking for riskier assets to invest in, and things that are more sensitive to growth and inflation. So yeah, really bad news, if it is coming back.

Black: And something else you're thinking about in the portfolios at the moment is demographics. So how does that inform your investing.

Leaviss: Well, I think the thing that's true about the U.K., true about Europe, and also true about the United States is that we're starting to look a lot more like Japan, and remember Japan's got a really old economy. So lots of retired people, people living to 100 and more. The longer you live, the more you need in secure safe assets, like fixed income, stuff that doesn't move around, stuff that pays you an income. And you also really are worried about inflation. So one theory is that when you get an economy like Japan with an old population, that population is going to vote for economic policies that keep inflation low, they're not worried about growth, they don't want animal spirits and everyone to have a good party. They want boring, nothing going on low inflation. And perhaps Italy has already shown the way there. But the rest of Europe and even the U.S. might turn into a kind of Japan style, low inflation world, unless we do really reignite these animal spirits over the course of next year or so.

Black: So Jim, lots of reasons for caution there. Can we end on a positive? Is there anything to feel good about in the bond world.

Leaviss: I think emerging market bonds look attractive. So bond yields as we talked about in the U.K., really low and boring, but go to Latin America, Asia, bits of Africa, of course, you're going to have these geopolitical risks, you're going to have issue, there's always going to be a default, from somewhere in Latin America, or a revolution in Africa. These things go on all the time, but you get paid for taking that risk. So if you're diversified across emerging market bonds, you can get real yields, inflation adjusted yields of 2% or 3% compared to minus 1% in boring old Europe. So there are areas if you want to take a bit more risk. But I'm afraid if you don't want to take any risk. You're stuck with boring old gilts at 1%.

Black: Jim, thank you for your time and thanks for joining us.

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Holly Black  is Senior Editor, Morningstar.co.uk