Which style of fund is better during rising inflation?

Conservative superannuation funds are likely to have had a similar or worse loss last financial year compared to balanced growth super funds, according to AMP Capital’s chief economist, Shane Oliver.

Reflecting on the previous financial year, Oliver said rising interest rates, bond yields and inflation had hit equities, property and bonds hard (shown in the chart below), driving an estimated -3% to -5% loss on balanced superannuation funds, after fees and taxes.

“It’s worth putting this in context though as in the 2020-21 financial year balanced growth super funds returned around 18.5% and over the last five years they returned 5.8% pa which is solid given that inflation averaged 2.6% pa,” he said.

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However, despite conservative funds having more exposure to the safer fixed income asset class, Oliver expected conservative funds to have had a similar or worse loss in the financial year due to hits to bond returns.

“Normally bonds are a safer less volatile asset class than shares, and so conservative funds tend to have a higher exposure to them than shares,” he said.

“However, every so often bonds have a rough ride at the same time as shares - usually when inflation is a big problem and central banks are raising interest rates which pushes up bond yields rapidly resulting in negative returns from both fixed income (as bonds suffer a capital loss when yields rise) and shares.

“The result is that both conservative and balanced growth funds can have poor returns in such environments as we have seen over the last year.”

He said the last time we saw something similar with poor returns from conservative and balanced funds was in the bond crash of 1994.

During this time, inflation fears saw central banks including the Reserve Bank of Australia raise interest rates aggressively from emergency levels after the early 1990s recession.

“This time around inflation has been much higher and bond rates have increased from even lower levels and so it’s been even more severe for bonds.”