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An equity investor’s guide to

RWC Equity Income 2020

For Professional Investors and Advisers Only RWC equity income

The team

Ian Lance has thirty years of experience in fund management and started working with Nick at Schroders in 2007 before joining RWC in August 2010. Whilst at Schroders he was a senior portfolio manager managing the Institutional Specialist Funds, the Schroder Income Fund and Income Maximiser Fund together with Nick. Previously Ian was the Head of European Equities and Director of Research at Citigroup and Head of Global Research at Gartmore.

Nick Purves joined RWC in August 2010. Nick worked at Schroders for over sixteen years, initially starting as an analyst before moving in to portfolio management where he managed both Institutional Specialist Value Funds and the Schroder Income Fund and Income Maximiser Fund together with Ian Lance. Prior to Schroders, Nick qualified as a Chartered Accountant.

John Teahan joined RWC in September 2010. He was previously portfolio manager at Schroders where he co-managed the Schroder Income Maximiser with Nick Purves and Ian Lance. In addition he co-managed the Schroder Global Maximiser, Schroder European Dividend Maximiser and Schroder UK Income Defensive funds, all three of which employed a covered call strategy. During his time at Schroders John also specialised in trading and managing securities for a range of structured funds. Previously he worked as a performance and risk analyst for of Ireland Asset Management UK. John is a CFA Charterholder.

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Introduction

We are sometimes told that will never work again because interest rates are going to stay permanently low thus favouring bonds and, by extension, -like equities. Ignoring the fact that there is no -term evidence of a correlation between interest rates and relative performance of growth versus value, and also ignoring the fact that interest rates appear to have hit a floor, these claims seem to assume that inflation will never be an issue again. That certainly seems to be the view of most investors looking at the chart of inflation expectations below.

Source: Bloomberg, 11 May 2020

In response to the economic damage caused by the UK lockdown, the last few weeks have seen the introduction of fiscal and monetary stimulus on an unprecedented scale that must at least increase the probability of a rise in inflation at some stage.

This note looks at what new measures have been employed, their theoretical origins, and why they could stimulate inflation in the future. It should be clear that this is not a prediction but merely an attempt to challenge the prevailing wisdom that the world will remain locked in permanently low inflation or deflation. The conclusion is that portfolios built for a world of low inflation and falling interest rates might struggle if that economic backdrop changed and that investors might want to for such a scenario.

The search for a new type of economics Just as the failure of economic policy to avoid the Great Depression gave birth to , and Keynesianism gave way to in the 1970s after the former was unable to explain simultaneously high inflation and high unemployment, so the failure of economics in recent years has left the environment ripe for considering new ideas such as Modern Monetary Theory (MMT).

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Failure of Monetary Policy Central bank’s post-financial crisis policy of cutting interest rates and quantitative easing is largely deemed to have been a failure. It has:

• Failed to generate sustainable levels of growth

Source: Bloomberg, 11 May 2020

• Failed to generate inflation above 2%, which is the objective of most central

Source: Bloomberg, 11 May 2020

• Has created a series of asset bubbles that are now in the process of unwinding

Source: Bloomberg, 11 May 2020

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• Increased inequality by boosting the prices of assets which were mainly owned by the wealthiest and hence fuelled the rise of populism

Source: Wid.world, Morgan Stanley Research

• Finally, although these policies were originally justified as being a temporary response to the Great Financial Crisis, they were not unwound before the latest downturn. This meant that central banks had nowhere to go when the latest downturn struck and went into this crisis with interest rates near zero (or negative in some cases) and with bloated central bank balance sheets.

Source: Bloomberg, 11 May 2020

Source: Bloomberg, 11 May 2020

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Failure of Fiscal Policy

• Among other things, the global financial crisis was largely considered to be a problem of too much making the extremely fragile. Governments have responded by taking on even greater levels of debt, albeit that much of it shifted from the private to the public balance sheet. This has led some to suggest that there are negative consequences of continually increasing debt to GDP1.

Source: Bloomberg, 11 May 2020

• This debt has not created economic growth but instead has slowed it. In the past 20 years, the ratio of federal debt to gross domestic product has leapt to 105% from 60% and GDP has grown at 1.2% a year, 37% below the long-term average. As Lacy Hunt of Hoisington Investment Management observes, “large indebtedness eventually slows economic growth as resources are transferred from the highly productive private sector to the government sector”. Ultimately, more and more debt is required to finance every dollar of GDP.

• The deficit is not self-financing as much of it is not put into productive assets, but rather used to fund welfare programmes.

Source: US Treasury, 30 April 2020

1 See for instance: ‘This Time is Different: Eight Centuries of Financial Folly’ by Reinhart and Rogoff

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Given these failures of post-crisis economic policy, it was not surprising that a new type of doctrine would be considered, and Modern Monetary Theory (MMT) is one such innovation.

What is Modern Monetary Theory? In a nutshell, MMT is the financing of government deficits via printed by the central banks. For anyone who wants to dig deeper into the subject, I have put a reading list in the appendix but for the moment I will summarise the core tenets of MMT.

• Money is a creation of the state and therefore sovereign governments cannot run out of money as they can always print more. This also means that a government will never on its since it can always print money to meet the debts that are coming due.

• One critical caveat of MMT is that a government can borrow as much as it likes if it is not owed to other nations. It is feasible to keep bond yields in check if your central bank is buying most of your debt, but if you are reliant on the ‘kindness of strangers’ then you are at risk of a buyers’ strike in government debt and a sudden surge in bond yields.

• Fiscal spending should be disconnected conceptually and practically from its financing. Spending should be focused on achieving full employment and should not be limited by deficits.

• MMTers believe that the only constraint on spending are the real resource constraints of the economy, and that inflation will result if spending is increased to a level beyond the productive capacity of the economy. Basically, anything (Universal Basic Income, Medicare for All, Green New Deal etc.) can be financed by printing money so long as it doesn’t trigger inflation. This necessarily means that the government takes a greater role in the allocation of resources in the economy and reduces the influence of the private sector.

• Taxes are not used to finance (as this is financed by money printing) but instead are used to slow the economy down.

How likely is it that MMT will be implemented? MMT has the potential to be immensely popular with the public and politicians alike since it effectively removes any limits on spending and allows the financing of projects likely to be popular with voters. In the current crisis, this enables governments to order workers to remain at home whilst paying them 80% of their salary. In the longer term it can finance just about anything from ever increasing amounts of spending on the NHS to universal basic income.

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Direct monetary financing of the government spending by the central bank is currently not allowed in most jurisdictions (central banks can only buy and sell government bonds on the ). Whilst I find it unlikely that full scale MMT is ever going to be implemented given its inherent flaws, I do believe that a version of it is currently being trialled as central banks start to finance (implicitly if not explicitly) the ballooning deficits required to deal with the coronavirus crisis.

Fiscal Response to the Coronavirus Crisis In the UK, economists at Citi estimate that the Treasury will borrow £273b this year taking the deficit to 14% of GDP which is not far from the 25% in the Second World War, and it is expected to remain above £100bn until 2024/25. For the first time, the state will spend over £1tn taking public expenditure to 52% of national income. It is likely that the UK’s debt as a percentage of GDP will exceed 100% by the end of 2020.

A leaked Treasury document discussed in The Daily Telegraph2 outlined an even worse scenario in which ‘the Treasury’s own ‘base case scenario’ for its budget deficit by the end of this financial year is £337b– more than £280bmore than pre-pandemic forecasts’. The Treasury’s “worst-case” scenario is for a deficit of £516b, although in the most extreme case it could be as high as £1.2tn.

Source: Bloomberg, 11 May 2020

In the US, the Treasury has just announced that they expect to borrow $3tn in the second quarter of 2020, and it is now forecast that the budget deficit will be $3.8b this year followed by $2.4tn next. A new bill for $1.5tn of added spending is now being debated which could take the deficit through $5tnthis year, and possibly more next year. Total national debt was $25tn at the end of April and is likely to increase substantially in both 2020 and beyond as GDP and tax revenues are likely to contract.

2 Treasury blueprint to raise taxes and freeze wages to pay for £300bn coronavirus bill Daily Telegraph 12 May 2020

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Source: Bloomberg, 11 May 2020

Altogether, the IMF estimates that so far, world leaders have committed to almost $8tn to battle coronavirus which will drive debt up to dangerously high levels. They expect global debts to hit 100% of GDP, jumping from 79.6% in 2012. The IMF expects the burden on developed countries to rise to more than 120% of GDP this year with the US at more than 131% and Italy’s debt rising to more than 155%.

Projected debt/GDP paths until 2030

160%

120%

80%

40%

Forecast 0% 2005 2010 2015 2020 2025 2030

USA UK Germany France Italy Spain

Source: Bloomberg, 11 May 2020 Source: Liberum, IMF, OECD, CBO

Monetary Response to the Coronavirus Crisis

The Bank of England The BoE has restarted its QE program and plans to buy another £200b of bonds, in addition to the £445b of bonds the bank already owns but at a recent Monetary Policy Meeting two members of the committee voted to increase this to £300b. The BoE is now directly monetising the deficit through the expansion of the ‘Ways and Means’ facility which will allow the government to bypass the bond market entirely until the Covid-19 pandemic subsides, financing unexpected costs such as the job retention scheme where bills will fall due at the end of April. The government announced it would extend the size of this facility, which normally stands at just £370m. This will rise to an effectively unlimited amount, allowing ministers to spend more in the term without having to

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tap the gilts market. In 2008, a similar move saw the facility rise briefly to only £20b. The BoE are insisting this is not helicopter money because it will be temporary (just as Ben Bernanke’s expansion of the Fed’s balance sheet was meant to be temporary).

The Federal Reserve The Fed has at least ten asset purchase programmes going including purchases of corporate debt, Treasury debt, municipal bonds, commercial paper, mortgages and more. Many of these are being done in a “special-purpose vehicle” using $425b given to the Fed by the Treasury as a kind of Fed bailout. Regardless of the legal structure, the Fed is on its way to printing $5tn of new money on top of the $5tn it has already printed. The charts below demonstrate how much larger and faster the Fed’s response has been to this crisis than prior ones.

Uncharted Territory: The Fed’s portfolio of bonds and new programs will swell to $8-11 trillion, economists estimate

Depression Era Modern Era and World War II 40

30

20 Federal Reserve balance sheet assets relative to GDP 10

0 1930 1950 2000 2020

Notes: Figures are as of year end, except final two. First 2020 assets figure is as April 22. Final 2020 estimate is based on WSJ Survey of Economists’ GDP forecast and the midpoint of analysts’ balance-sheet estimate, $9.5 trillion. Sources: Federal Reserve Bank of St. Louis, FRED and Fraser databases (assets); Commerce Department (GDP)

Rapid response: Fed asset holdings have grown more sharply than during past quantitative easing, or QE, periods in which the Fed bought nearly $4 trillion in securities* to stimulate the U.S. economy Change in holdings since the start of each program

$2.0 trillion QE1: December 2008- Since June 2010 1.5 March 11 QE3: Sepember 2012- October 2014 1.0

0.5 QE2: November 2010- June 2011

0 0 10 weeks 20 30 40 50 60 70 80 90 100 110 WEEKS INTO EACH PROGRAM

*Treasurys, mortage-backed securities and Fannie Mae and Freddie Mac debt. Source: Federal Reserve Bank of St. Louis, 30th April 2020

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Other central banks have also announced significant intervention with the ECB forecast to increase their balance sheet by $3.4tn by the end of 2021 and the BOJ another $609b.

Why did previous QE not lead to inflation? Some have suggested that this increase in money printing will not lead to inflation because previous QE did not lead to consumer price inflation (even if it caused massive asset price inflation). It is therefore worth recapping why previous QE did not cause inflation.

QE merely changes the composition of private sector savings from bonds to reserves, while it does little to change the level of savings. As John Hussman3 explains: ‘quantitative easing is nothing but an asset swap. It doesn’t change the total amount of government liabilities in circulation. It only changes the form of the government liabilities that must be held by the public. The central bank buys government bonds and in return it creates base money ( and bank reserves) that must be held instead. What QE does not change is the total quantity of government liabilities in circulation. That decision isn’t under the control of monetary policy but is instead determined by fiscal (tax and spending) policy’.

Thus, while QE failed to create consumer inflation, it generated much asset price inflation due to huge reserve creation that worsened wealth inequality.

Near term outlook is deflationary Others4 have also suggested that the near-term outlook is more likely to be deflationary than inflationary and it is hard to disagree with that point. In the near term, rising unemployment, increasing levels of bankruptcies, debt defaults and a hit to both household and corporate income will likely be deflationary.

Source: Bureau of Labor Statistics, 8 May 2020

3 How to Needlessly Produce Inflation by John Hussman 06/08/2019 4 See for instance Inflation or Deflation? Collapse in Demand Trumps Supply Shocks by Mike Shedlock

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Source: Institute for Supply Management (ISM), 30 April 2020

Others have pointed out, correctly, that although the supply of money is increasing, the velocity is still declining, and it is unlikely that inflation will increase in these circumstances.

5

Source:Federal Reserve, 31 March 2020

5

Source:Federal Reserve, 31 March 2020

5 M2 is a calculation of the that includes all elements of M1 as well as “near money.” M1 includes and checking deposits, while near money refers to savings deposits, securities, mutual funds, and other time deposits. These assets are less liquid than M1 and not as suitable as exchange mediums, but they can be quickly converted into cash or checking deposits.

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Why might the inflationary risks be greater than with previous QE? Even though the near-term outlook seems to be deflationary, it seems relevant to note that the current policies are not identical to those used after the Great Financial Crisis (GFC) which means that it may not be correct to assume identical effects. John Hussman again…

‘After years of extraordinary monetary policy and quantitative easing in Europe, Japan, and the United States, one thing should be clear: quantitative easing does not produce inflation. Rather than asking why this has been so, many observers have been quick to pronounce inflation “dead,” as if the world has permanently changed, and there are no conditions that would cause inflation to bear its fangs. Advocates of “modern monetary theory” (MMT) are attracted to this idea6. There are, however, notable differences between the post-GFC response and more recent actions:

1. Scale of the monetary intervention As the charts above have shown, the scale of the monetary intervention has been significantly larger and more aggressive than following the financial crisis. The G4 central banks will increase their balance sheets by a collective 30% of GDP in this cycle and the Fed’s balance sheet will expand by 38% of GDP by 2021, more than the 20% during QE1, 2 and 3 combined. And it does not look like they intend to stop any time soon judging by Jay Powell’s comments in his recent 60 Minutes Interview:

POWELL: ‘Well, there’s a lot more we can do. We’ve done what we can as we go. But I will say that we’re not out of ammunition by a long shot. No, there’s really no limit to what we can do with these lending programs that we have. So, there’s a lot more we can do to support the economy, and we’re committed to doing everything we can as long as we need to.’

2. Coordinated monetary and fiscal response After the GFC, governments initially used to stimulate the economy but then responded with austerity. Central bankers such as Mario Draghi constantly protested that the heavy lifting could not be done by the central banks alone and that governments needed to play their part. This seems to have been recognised in the current crisis and governments have significantly stepped up deficit spending. In this cycle, the combined G4 fiscal deficit will rise to 14% of GDP in 2020 from 2.9% in 2019, 1.6 times 2009 levels. The US fiscal deficit is projected to reach 19.2% of GDP this year.

US fiscal deficit projected at 19.2% of GDP – the highest since 1936 US Headline Fiscal Balance (% of GDP)

2% -3% -8%

-13% 1929-38 -18% -19.2% -23% If there is an additional $1trn stimulus -24.1% -28%

1920 ‘24 ‘28 ‘32 ‘36 ‘40 ‘44 ‘48 ‘52 ‘56 ‘60 ‘64 ‘68 ‘72 ‘76 ‘80 ‘84 ‘88 ‘92 ‘96 2000 ‘04 ‘08 ‘12 ‘16 ‘20

Source:BEA Federal Reserve, Morgan Stanley Research forecast. Monetary dominance is being replaced by fiscal dominance and hence the tail risk potentially shifts from low inflation or deflation to higher inflation as we saw in the 1970s.

6 How to Needlessly Produce Inflation by John Hussman 06/08/2019

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3. These deficits are being funded by central banks In the Financial Times recently, Stephanie Kelton7 and Edward Chancellor argued the case for and against MMT. Most mainstream economists consider MMT so farfetched that they have dismissed it and do not believe that it is ever likely to be implemented. In Chancellor’s piece, however, he suggests that it is effectively happening already.

‘As theory, MMT has been rejected by mainstream economists. But as a matter of practical policy, it is already being deployed. Ever since Ben Bernanke, as governor of the US Federal Reserve, delivered his “helicopter money” speech in November 2002, the world has been moving in this direction. As president of the European Central Bank, Mario Draghi proved that even the most indebted countries need not default. Last year, the US federal deficit exceeded $1tn at a time when the Fed was acquiring Treasuries with newly printed dollars — that’s pure MMT.

This crisis has accelerated the process. Fiscal and monetary policy are now being openly coordinated, just as MMT recommends. The US budget deficit is set to reach nearly $4tn this year. But tax rises are not on the agenda. Instead, the Fed will write the cheques. Across the Atlantic, the Bank of England is directly financing the largest peacetime deficit in its history. MMT claims that money is a creature of the state. The Fed’s share of an expanding US money supply is close to 40 per cent and rising. Again, we are seeing MMT in practice8.

One of the best studies of high and hyperinflation is ‘Monetary Regimes and Inflation’ by Peter Bernholz in which he notes ‘There has never occurred a hyperinflation in history which was not caused by a huge budget deficit of the state. In all cases of hyperinflation deficits amounting to more than 20% of public expenditures are present’. In addition, he notes that central bank financing of government deficits past certain thresholds is associated with high or hyper inflationary episodes. Bernholz focused on the ratio of budget deficits to expenditures and found that in all episodes of hyperinflation this ratio had exceeded 40% in the years leading up to it and that the central bank was monetising a high proportion of government debt. The chart below shows that the US and Japan have now exceeded the 20% level and would be close to or above 40% in the event that interest rates increased. Deficits as share expenidures today and if interest costs increase by 1%

Source: Liberum, Bloomberg

7 Professor of Economics at Stony Brook University and one of the leading proponents of MMT 8 ‘Can governments afford the debts they are piling up to stabilise economies’ Edward Chancellor, Financial Times 3 May 2020

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4. The loss of central bankers independence The idea behind making central banks independent was that they would be willing to take actions which might be unpopular with politicians and voters but were in the long-term benefit of the economy. Conversely, it would stop central banks doing things that were popular with their political leaders but could harm the economy. Arthur Burns, the Chairman of the Federal Reserve in the 1970s, can be heard on the Nixon tapes walking in to the Oval Office and saying to Nixon that ‘the election is a year away, I think it’s time to juice the economy’ which is exactly what he did and contributed to the high inflation of the seventies. He was replaced by Paul Volker who was willing to take interest rates all the way to 20% in June 1981 in order to get inflation under control but was arguably the last truly independent Chairman of the Federal Reserve. In the US, Jay Powell has proven himself happy to bow down to the President and/or the markets demands. In Europe, Christine Lagarde has said she was ‘open to the idea that the ECB use its tools to effect change towards a green transition in the economy’. It is very hard to see any of the current crop of central bankers as truly independent.

In MMT, the central bank is regarded as part of the consolidated government sector whose only function is to provide direct funding to the government to accommodate spending as needed to reach its economic goals. This appears to be, implicitly if not explicitly, the situation in several of the world’s largest economies.

5. Will politicians stop? Governments have an inherently inflationary bias as their default is to spend money on people likely to vote for them but rather than finance this with taxes which is politically unpopular, they finance it with debt. In addition, discontent among voters with previous policy responses which seemed to favour Wall Street over Main Street is likely to lead to a change in focus. In the UK Boris Johnson, has already pledged that there will be no austerity9. Given the lack of any current constraint on their spending, it appears likely that politicians will keep the spigots firmly open.

As David Einhorn of Greenlight commented in his first quarter letter ‘Now that the fiscal dam has burst, the authorities have no incentive to slow the support. Stimulus packages 1,2 and 3 will likely be followed by 4,5 and. The Fed will create money and (and attempt to supress interest rates) to support the economy.’

Elsewhere10, Paul Singer noted that politicians ‘got away with unsound policy for twelve years. Now they think they have the magic formula; the one size fits all nostrum that enables them to control the curve and promise and deliver unlimited amounts of money without cost and without risk. They are wrong.’

9 ‘No public sector pay freeze and no austerity as UK emerges from coronavirus crisis’ Daily Telegraph 15th May 2020 10 Elliott Capital Q1 2020 Investor Letter

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6. Supply shocks In the short term there is a possibility that disruption to production and supply chains leads to shortages in areas like food which feeds through to higher prices. In the longer term, however, global trade faces increased scrutiny in a post Covid-19 world and policy makers are likely to demand more resilient local supply chains. The era of globalisation which had depressed both wages and prices of international goods and kept the lid on inflation may well be coming to an end with inevitable consequences. In this piece for the Financial Times, former Morgan Stanley economist Stephen Roach makes a convincing case for the return of stagflation:

‘the anti-China weaponisation of supply chains promises to riddle global production systems with bottlenecks. Inflation will not return while the recession deepens. But as recovery takes hold, a new world of fragmented, more expensive supply chains may tell a different story. Soaring deficits and debt could compound the problem. For now, no one is worried about them because of a conviction that interest rates will stay at zero forever. But with fractured supplies set to push inflation higher, that assumption will be tested.

7. Psychology One final point is that inflation is ultimately determined by psychology which is not a linear thing and hence very hard to predict. Savers may be happy to hold government bonds one minute but become less confident the next and when this occurs, they will want to get rid of them by spending. ‘What inflation requires is public revulsion to government liabilities , and what produces public revulsion is the creation of government liabilities at a rate that destabilizes the expectation that those liabilities remain sound… if you want more inflation, the way to get it is by running government deficits that are out of line with sustainable norms’11.

As I have shown above, most governments appear to be running deficits out of line with sustainable norms and it should therefore not surprise us if public confidence in government liabilities (whether bonds or currency) is destabilised.

What would investors need to do differently? For at least the 12 years since the financial crisis ended, investors have been used to an investment landscape in which interest rates fell, central banks printed money without any inflationary consequences and nearly all asset classes went up. Within equities, long duration (quality and growth) went up the most, and were encouraged to take on ever increasing amounts of debt via share buybacks which also had the side effect of driving their shares prices up.

I might be wrong, but it does not feel like the next ten years is going to be as usual and I do wonder whether we might be witnessing the start of a regime change in which governments run significantly higher deficits financed in a major way by central bank money printing. Investors need to be aware that the central tenet of MMT is that government spending is not limited by debt

11 ‘How to needlessly produce inflation’ by John Hussman August 2019

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and deficits by merely inflation. The idea that there is someone inside a government department who can spot inflation in advance and then persuade politicians to increase taxes or cut spending is fanciful. In which case, it seems to me that governments have been given the green light to massively increase spending, debts and deficits and will only stop once inflation has become established. Just as toothpaste is hard to get back in the tube once it has been squeezed out, so inflation is hard to bring under control once it has taken hold and changed consumers expectations.

In this new MMT world where inflation becomes a higher risk, investors will have to adjust to an investment landscape that has not been witnessed since the 1970s. Specifically, they might think about the following:

• Equities and bonds could become positively correlated but do badly at the same time which was certainly the case in the 1970s (see chart below). This would create difficulties for strategies based around the idea that they were negatively correlated such as the traditional 60/40 portfolio and risk parity.

Source: Variant Perception, 31st April 2020

• In the 1970s, real assets performed much better than financial assets. The chart above shows that produced a real return of 23% during the seventies but gold produced a real return of 553% during a similar period12.

• Unsurprisingly, within equities, the best performing sectors were those that benefitted from rising prices such as energy and materials.

12 Variant Perception, 31st April 2020

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Source: Variant Perception, 31st April 2020

• The final lesson is that starting valuation counted for a lot during this decade. The chart below from Research Affiliates shows that the valuation spread between value and growth was very significant at the start of this decade (bottom line) and that subsequently, value stocks outperformed significantly (top line). Point E on the chart represents current conditions where the valuation dispersion is even greater.

HML Value Factor Performance and Relative Valuations, US July 1963 - Mar 2020

Point A represents the starting point of analysis Point B represents the discovery of the value premium by Basu (1977) Point C represents the crash of the tech bubble Point D represents the global financial crisis Point E is the ending point Source: Research affiliates, LLC, using data from CRSP/Compustat

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The other interesting analogy with the 1970s is that the index was dominated by a handful of quality growth that were so adored by investors that they started the decade on very high valuations. These stocks became known as the Nifty 50 and were a group of high-quality stocks such as Xerox, IBM, Polaroid and Coca-Cola. Most of these stocks were leaders in their industry, with strong balance sheets, high profitability, proven high growth rates and continual increase in . This seems eerily familiar to conditions today as the valuations of quality growth stocks re-rate ever upwards.

As the chart below shows, however, even though these market darlings delivered expected profitability, the total returns to investors were disastrous and the Nifty 50 group underperformed the market by c. 40% over the following four years. Investors owning today’s quality growth cohort would do well to heed this lesson if economic conditions ever again mirrored those of the seventies.

Source: Exane, 31st April 2020

Conclusion Anyone who has predicted any increase in inflation in the last decade has been wrong and will now be compared to the little boy who cried wolf. This can, of course, create complacency in investors who assume that because inflation has not occurred recently, it will never happen again. As I stated earlier, this is not a prediction that inflation is imminent, but it is evident that continued very low inflation is being priced into financial markets. Given this widespread certainty that the status quo will continue, a shift in the level of inflation expectations would have serious consequences for asset prices. As I have argued above, recent policy initiatives are both different and far larger than previous actions (and I don’t believe they are yet exhausted) and this must suggest an increase in the likelihood of inflation occurring at some stage. I would never attach a probability to this but I know that it is not zero and hence we believe investors would be wise to think about altering their asset exposure to at least give them some protection in the event that financial markets start to price in a rise in the level of inflation.

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Bibliography

The Return of Inflation, Morgan Stanley 10th May 2020

How to Needlessly Produce Inflation by John Hussman 6th August 2019

Turtles All the Way Down by John Hussman 4th February 2019

It’s Coming! Its Coming! MMT (or something) is Coming by Dylan Grice 29th October 2019

Too Soon? Pandemic Policy Response Raises Risk of Inflation by Research Affiliates April 2020

The Next Generation of Monetary Policy by Variant Perception May 2019

Modern Monetary Theory Isn’t Helping by Doug Henwood 28th February 2019

Modern Monetary Theory: The Magic Money Tree Explained by George Cooper February 2019

MMT Sounds Great in Theory…. But by realinvestmentadvice.com 19th February 2019

We’re All MMT’ers Now by Ben Hunt, Epsilon Theory 25th July 2019

A New Road to Serfdom by Ben Hunt, Epsilon Theory 24th January 2020

Why More Money Can’t Generate Growth by Dr Frank Shostak (Cobden Centre) 28th January 2020

Dealing with the Next Downturn: From Unconventional Monetary Policy to Unprecedented Policy Coordination by BlackRock Investment Institute August 2019

MMT: What’s Right is Not New, What’s New is Not Right, and What’s Left is Too Simplistic by Willem Buiter, Citi 8th April 2019

MMT: The Court Astrologers Dream by Sean Corrigan of Cantillon Consulting 4th February 2019

Debasing the Baseless – Modern Monetary Theory by Colin Lloyd (Cobden Centre) 13th May 2019

MMT, AOC, OMG – What Investors Need to Know About Modern Monetary Theory by Bernstein 18th December 2019

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RWC may act as investment manager or adviser, or otherwise provide services, to more than one product pursuing a similar investment strategy or focus to the product detailed in this document. RWC seeks to minimise any conflicts of interest, and endeavours to act at all times in accordance with its legal and regulatory obligations as well as its own policies and codes of conduct.

This document is directed only at professional, institutional, wholesale or qualified investors. The services provided by RWC are available only to such persons. It is not intended for distribution to and should not be relied on by any person who would qualify as a retail or individual investor in any jurisdiction or for distribution to, or use by, any person or entity in any jurisdiction where such distribution or use would be contrary to local law or regulation.

This document has been prepared for general information purposes only and has not been delivered for registration in any jurisdiction nor has its content been reviewed or approved by any regulatory authority in any jurisdiction. The information contained herein does not constitute: (i) a binding legal agreement; (ii) legal, regulatory, tax, or other advice; (iii) an offer, recommendation or solicitation to buy or sell shares in any fund, , commodity, or derivative linked to, or otherwise included in a portfolio managed or advised by RWC; or (iv) an offer to enter into any other transaction whatsoever (each a “Transaction”). No representations and/or warranties are made that the information contained herein is either up to date and/or accurate and is not intended to be used or relied upon by any counterparty, investor or any other third party.

RWC uses information from third party vendors, such as statistical and other data, that it believes to be reliable. However, the accuracy of this data, which may be used to calculate results or otherwise compile data that finds its way over time into RWC research data stored on its systems, is not guaranteed. If such information is not accurate, some of the conclusions reached or statements made may be adversely affected. RWC bears no responsibility for your investment research and/or investment decisions and you should consult your own lawyer, accountant, tax adviser or other professional adviser before entering into any Transaction. Any opinion expressed herein, which may be subjective in nature, may not be shared by all directors, officers, employees, or representatives of RWC and may be subject to change without notice. RWC is not liable for any decisions made or actions or inactions taken by you or others based on the contents of this document and neither RWC nor any of its directors, officers, employees, or representatives (including affiliates) accepts any liability whatsoever for any errors and/or omissions or for any direct, indirect, special, incidental, or consequential loss, damages, or expenses of any kind howsoever arising from the use of, or reliance on, any information contained herein.

Information contained in this document should not be viewed as indicative of future results. Past performance of any Transaction is not indicative of future results. The value of can go down as well as up. Certain assumptions and forward looking statements may have been made either for modelling purposes, to simplify the presentation and/or calculation of any projections or estimates contained herein and RWC does not represent that that any such assumptions or statements will reflect actual future events or that all assumptions have been considered or stated.

Forward-looking statements are inherently uncertain, and changing factors such as those affecting the markets generally, or those affecting particular industries or issuers, may cause results to differ from those discussed. Accordingly, there can be no assurance that estimated returns or projections will be realised or that actual returns or performance results will not materially differ from those estimated herein. Some of the information contained in this document may be aggregated data of Transactions executed by RWC that has been compiled so as not to identify the underlying Transactions of any particular customer.

The information transmitted is intended only for the person or entity to which it has been given and may contain confidential and/or privileged material. In accepting receipt of the information transmitted you agree that you and/or your affiliates, partners, directors, officers and employees, as applicable, will keep all information strictly confidential. Any review, retransmission, dissemination or other use of, or taking of any action in reliance upon, this information is prohibited. The information contained herein is confidential and is intended for the exclusive use of the intended recipient(s) to which this document has been provided. Any distribution or reproduction of this document is not authorised and is prohibited without the express written consent of RWC or any of its affiliates.

Changes in rates of exchange may cause the value of such investments to fluctuate. An investor may not be able to get back the amount invested and the loss on realisation may be very high and could result in a substantial or complete loss of the investment. In addition, an investor who realises their investment in a RWC-managed fund after a short period may not realise the amount originally invested as a result of charges made on the issue and/or redemption of such investment. The value of such interests for the purposes of purchases may differ from their value for the purpose of redemptions. No representations or warranties of any kind are intended or should be inferred with respect to the economic return from, or the tax consequences of, an investment in a RWC-managed fund. Current tax levels and reliefs may change. Depending on individual circumstances, this may affect investment returns. Nothing in this document constitutes advice on the merits of buying or selling a particular investment. This document expresses no views as to the suitability or appropriateness of the fund or any other investments described herein to the individual circumstances of any recipient.

AIFMD and Distribution in the European Economic Area (“EEA”).

The Alternative Fund Managers Directive (Directive 2011/61/EU) (“AIFMD”) is a regulatory regime which came into full effect in the EEA on 22 July 2014. RWC Asset Management LLP is an Alternative Manager (an “AIFM”) to certain funds managed by it (each an “AIF”). The AIFM is required to make available to investors certain prescribed information prior to their investment in an AIF. The majority of the prescribed information is contained in the latest Offering Document of the AIF. The remainder of the prescribed information is contained in the relevant AIF’s annual report and accounts. All of the information is provided in accordance with the AIFMD.

In relation to each member state of the EEA (each a “Member State”), this document may only be distributed and shares in a RWC fund (“Shares”) may only be offered and placed to the extent that (a) the relevant RWC fund is permitted to be marketed to professional investors in accordance with the AIFMD (as implemented into the local law/regulation of the relevant Member State); or (b) this document may otherwise be lawfully distributed and the Shares may lawfully offered or placed in that Member State (including at the initiative of the investor).

Information Required for Distribution of Foreign Collective Investment Schemes to Qualified Investors in Switzerland.

The Swiss Representative and the Paying Agent of the RWC-managed funds in Switzerland is Société Générale, Paris, Zurich Branch, Talacker 50, P.O. Box 5070, CH-8021 Zurich. In respect of the units of the RWC-managed funds distributed in and from Switzerland, the place of performance and jurisdiction is at the registered office of the Representative in Switzerland. The Confidential Memorandum, the Articles of Association as well as the annual report may be obtained free of charge from the Representative in Switzerland.

No investment strategy or risk management technique can guarantee returns or eliminate risks in any market environment. 21