• Inflation is on the rise, but investors don’t need to worry yet.
• Suzanne Hutchins, a portfolio manager at Newton Investment Management overseeing $8 billion, breaks down her take on inflation.
• Hutchins shares 4 ways to position for rising inflation and her outlook on bitcoin.

Inflation is picking up. Asset prices are highly elevated, while food and commodity prices are rising.

That isn’t necessarily a bad thing, according to Suzanne Hutchins, a portfolio manager at Newton Investment Management, a firm that oversees £46 billion ($64 billion) assets under management.

She co-manages the £6 billion ($8 billion) Real Return fund, which leverages an absolute return approach.

Hutchins, who started working in the industry in 1991, experienced a time when inflation and interest rates were much higher than they are now.

Many managers and investors today only know low inflation and rock-bottom rates, and will need new tools to generate returns, she said.

US consumer price inflation, excluding food and energy, is currently around 1.4%. This rate has rarely moved above 2% since the financial crisis of 2008, while between the mid-1970s and mid-1990s, it hardly ever dropped below 4%.

A massive regime shift catalyzed by COVID-19 is underway, Hutchins said. This started back in 2008, when central banks began pumping massive quantities of money into the financial system to keep credit flowing to the real economy and keep borrowing rates low. In theory, this should have created pricing power and growth. Instead, it inflated asset prices, but did not spark the pickup in inflation policymakers had intended.

Now, fiscal and monetary policy are working in tandem to create a new norm, which means Hutchins is having to tear up the investing playbook developed over the last decade as reflation starts to come through.

"There's a lot of money in the financial system and when that money gets put to work and the velocity of money goes up, that's when you're going to see inflation," Hutchins said.

The biggest risk is inflation getting out of control and central banks raising rates in response, Hutchins said.

"The worst of all worlds is for real rates to go up, because that's bad for equities," Hutchins said. "It's bad for bonds and actually bad for gold as well."

Markets are not reflecting expectations for a damaging spike in inflation right now. But some investors are worried even a small uptick could impact stocks, particularly high-growth stocks whose future value is calculated based on near-zero interest rates.

The Federal Reserve has promised not to increase interest rates even if inflation moves above its 2% target.

"As long as rates [are] pinned, which is what Fed policymakers are talking about, then you're going to get earnings growth coming through, which will continue to drive equity markets higher," Hutchins said.

Positioning for rising inflation

The real return fund is long only and not constrained by asset class. Hutchins sees the portfolio as being split into a return-seeking core, which contains equities, high-yield debt and alternative investments, and a stabilizing core, which could include government bonds, gold and currencies.

The combination provides a much smoother return profile than solely holding equities or bonds, Hutchins said.

This is how Hutchins is looking at various assets for rising inflation:

Equities

Equities generally will benefit from an increase in controlled inflation, Hutchins said. She recommends holding equities on a selective basis, because there will be a massive bifurcation between winners and losers.

"What I've seen so often in economic recoveries is the businesses that have got the most leverage on their balance sheet and the ones that are cash constraints are the ones that go to the wall, because as the economy recovers. They can't get cash into their business fast enough to keep the the wheels in motion," Hutchins said. "So you've got to be really selective over making sure you haven't got businesses that are highly indebted."

Domestic bonds

Bonds have historically stabilized the volatility of the equity markets, but Hutchins believes that's now changing dramatically and is now cutting domestic bonds.

"Bonds tactically provide a good hedge in the short term, but longer term they don't," she said. "So I think you want to be looking to exit bonds."

Emerging market debt

Emerging markets debt looks really good, because emerging markets don't have the same levels of indebtedness as they did previously, inflation is quite contained, real rates are coming down and currencies look attractive, Hutchins said.

Gold

"I would still have exposure to gold, I don't think the gold price is too expensive," Hutchins said.

Relative to the equity markets over the last 10 years, gold is still underpriced, Hutchins said.

"It's a store of value, which can't be printed, or manipulated," Hutchins said. "So I think it does have value in a portfolio, would I put all my money into it? No."

And what about bitcoin?

Many bitcoin investors refer to the asset as a potential inflation hedge, highlighting its similarities to gold.

Institutional investors and big companies are also getting involved. Ruffer Investment Management recently placed a 2.5% stake in bitcoin as a hedge against inflation and currency debasement.

"I've certainly given [bitcoin] a lot of thought," Hutchins said. "I'm interested in it both from a personal basis and thinking about it as a different type of asset class. I don't think anybody can yet say it's an inflation hedge.  I think it's all very tenuous to make those sorts of correlations."

The real return strategy is ultra-conservative, Hutchins said. She wants to be able to understand all the assets and their potential risks, which she doesn't currently for bitcoin.

"I think it's very fashionable, but I definitely think that there needs to be more grounding to it, and a framework of regulation, and control for it to become legal paper, and I wouldn't want to be risking our clients money in something that I can't explain," Hutchins said.