Alongside a potential recession and lower global economic growth looming in 2023, defined benefit pension plan sponsors have several tools to minimize the impact of rising inflation, said Eric Menzer, senior portfolio manager and global head of outsourced chief investment officer and fiduciary solutions and multi-asset solutions at Manulife Investment Management, during a session at the Canadian Investment Review‘s 2022 Risk Management Conference.

“We’re in good [economic] shape, roughly speaking. Household balance sheets are really in good shape. Corporate balance sheets are in really good shape. . . . The focus will shift as we get into 2023 for sure.”

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The primary way DB plans can reduce the impact of inflation is through real return bonds, he said, noting the U.S. market is stronger than Canada. While there are pros and cons, the asset class provides plan sponsors with an option to help hedge against long-run, break-even inflation rates.

“The key there is to find your inflation duration . . . and coming up with a number there in terms of measuring your sensitivities. Once you’ve nailed that down and you have a long-term strategy, real return bonds on a buy and hold for the long-term can help. It’s just you’re going to have some noise in between as you get bumps up in the consumer price index like we have right now, where break-evens don’t match with what the [consumer price index] is doing.”

While real estate can also provide an effective inflation hedge amid increasing rents, Menzer suggested pension plan sponsors balance these investments with other real assets including commodities like oil and gas, as well as timberland and farmland, said. He noted a diversified basket of real assets provides lower correlations and increases inflation protection within a portfolio.

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“We’ve seen the rents go up quite a bit over the last two years. You’ve seen it here in Canada. We’re seeing it in the States as well. It’s pretty substantial. That’s an inflation hedge. [But] how much longer will that train continue to run? The key is to have different types of real assets that have flexibility to pass those costs down so that the investor benefits from those rising prices.”

Plan sponsors can also make use of growth assets to hedge against inflation, he said, noting this strategy has increased in popularity in recent years. “It’s pretty commonplace to talk about how to allocate the capital between growth and hedging. Sometimes it’s static, sometimes there’s a glide path. . . . Not only [are growth assets] helping you … hit your target return, but it also gives you that ballast and protection against inflation.

“Because if we do get in an environment where inflation is transitory, [when] the economy starts growing back, then your allocation of growth assets are going to help offset that.”

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