The new age of runaway inflation means it's time to stop measuring active investment managers' performances against benchmarks like the S&P 500.
That's the take from Inigo Fraser Jenkins, one of the most famous quant analysts on Wall Street. In a research paper published this week, he and his colleagues said that simply matching or beating a broad index most likely doesn't deliver enough excess return to keep up with inflation that has made covering living expenses harder by the day.
"For many investors, the ultimate benchmark they should care about is meeting 'liabilities' set in the real economy, such as meeting the cost of retirement," the co-head of institutional solutions at AllianceBernstein wrote in the report. "That means inflation should be the benchmark."
Switching the yardstick would make life even more difficult for a cohort of professionals who have been struggling for years to beat indexes that own broad swaths of the market. Though recent data suggest inflation may have peaked after topping 9%, it still sits near levels not seen in decades. And the Federal Reserve's efforts to tamp it down have left almost every major financial asset lower for the year.
With the exception of commodities, all major assets — from stocks to Treasuries to corporate bonds — have seen inflation-adjusted losses exceeding 18% this year, data compiled by Bloomberg show.
At its worst levels of the year, hit in October, the S&P 500 was still 6% above its prior peak set before the Covid crisis. When inflation is taken into account, however, all the post-pandemic gains were gone.
"It's very hard in a period of rising inflation to look to exceed that CPI performance," said Sandi Bragar, chief client officer at Aspiriant. "It's not feeling good to do that comparison in 2022."
The idea of using inflation as a yardstick for fund performance is part of a framework that Fraser Jenkins presented to build a case for a revival of active management. The analyst, who once called passive investing worse than Marxism, forecast that a return of the business cycle and volatile markets will erode the appeal of passive funds.
It's not that inflation is not a consideration at all for money managers. It's just that decades of low inflation, along with a friendly central bank, have fueled an everything rally that makes performance erosion an afterthought. Now, with price pressures raging, the issue of real return is again moving to the front of investors' minds.
Changing up in 2022 would be unusually harsh for active managers, many of whom are delivering standout results when measured against traditional benchmarks. Together, the group is on course for the best year since 2018, as 42% of funds had topped their indexes through October, according to data compiled by Bank of America.
Yet with all but one of the 11 major industries in the S&P 500 nursing losses this year, expecting any stock pickers to beat inflation is a lot to ask. The average fund was down 21% during the first 10 months, BofA data show.
To Vincent Berard, the head of product strategy for BNP Paribas Global Markets' quant team, a more sensible approach is incorporating the inflation factor into portfolio constructions.
"One could challenge whether this is a sustainable objective on a longer term -- it could be seen as a bit narrow, even though it can interest some investors," said Berard. "We have many discussions at the moment with clients on how existing solutions or, potentially a portfolio of solutions, can provide the correct positioning for various inflation scenarios."
