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27 October 2020

USS Investment Management Update - October 2020

As we look forward, the final quarter of 2020 looks to be one of the most challenging in recent history. With the looming US election poised to be highly contested, a potential cliff-hanger Brexit deadline and a global pandemic still unfolding, calling the future direction of the global economy and financial markets is at its most difficult.

It doesn’t take much to imagine how we could be at a major turning point. For example, while we have been used to low and stable inflation across most developed countries over the last 20 years with the help of central bank independence, a new pattern could possibly emerge from the ashes of the global pandemic.

Over the next couple of years deflationary pressures are more likely to prevail. Inflation was already low before the pandemic hit and, with a pick-up in unemployment now a near-certainty as support measures are unwound, many forecasters expect consumers to put the brakes on spending. This will be particularly acute in sectors such as the travel and hospitality industries. Indeed, the Bank of England is already looking to sharpen its tools to fight deflationary pressure and has signalled to lenders to prepare for negative interest rates.

However, we can imagine how a shift towards greater state involvement in the economy could lead to higher inflation over the longer-term. Fiscal policy might shift to higher spending and taxing, with a more redistributive tilt to reduce income inequalities. If this happens in combination with protectionism, trade barriers and a less globalised world it could generate inflationary pressures. Crucially and finally, governments might have little inclination to allow central banks to counter inflation and “spoil the party”.

So how do we best manage members’ money at such an uncertain time? In the first instance, we are alive to the challenges we face. We take scenario planning very seriously and have mapped out what we think may be coming down the track and how to react accordingly.

Our investment strategy has aimed to take advantage of favourable market conditions to allocate to asset classes where we plan to strategically increase our exposure in the longer term. We always maintain a close eye on diversifying our portfolio allocations and effectively manage our risks versus liabilities.

For example, we took advantage of the market’s fear of deflation during the Covid-19 shock to increase our exposure to inflation-hedging assets. As well as UK Gilts, these include allocations to US and European inflation-linked bonds, where pricing remains attractive due to lack of inflation hedging demand from pension funds.

We also took advantage of much wider credit spreads after March by acquiring high quality credit assets and have directed our effort to build a portfolio of long-dated sterling credit instruments through a co-ordinated effort between our Public and Private Market investment teams.

Recently we have also taken steps to improve the diversification of our foreign exchange exposure and increased allocations to currencies with defensive properties during turbulent times such as the Japanese yen.

So, while we maintain a cautious stance, we remain ready to take advantage of market opportunities when they present themselves. And while there is clearly no crystal ball available, we are well-positioned to deal with the uncertainty ahead.

Nothing in this article should be construed as an offer, invitation or general solicitation to buy or sell any investments or securities, provide investment advice or to engage in any other transaction or service.