Inflation is one of the major common macro factor risks that can impair real investment returns for long term investors. ATLAS recognises that there are two main mechanisms through which increasing inflation can impact investors’ returns:
Direct impact to real equity cashflows – higher inflation will usually feed into changes to revenues and operating costs for companies. Depending on the rate of inflation pass through, this will result in changes to real returns for equity holders
Through altering the overall macro environment for assets – historically, periods of higher inflation do not occur in isolation and are often associated with higher bond rates, lower economic growth and higher required returns on equity (increased market risk premium). This type of ‘stagflation’ macro environment provides both a direct stress to cashflows as well as a stress to the cost of capital, especially where asset owners are unable to pass higher capital costs through to users.
The direct inflation pass through impact provides the most useful guide to understanding how longer term, incremental changes to inflation will impact asset returns. The macro environment mechanism provides a more useful guide to the likely ‘real world’ impact of an unexpected and sustained rise in inflation.
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