In times of high inflation, equity could be the only way of earning a positive return on one’s investments. However, the clutches of inflation can squeeze margins of even robust companies. Ramkrishna Kashelkar presents a few themes that can potentially shield investors from the deadly fangs of inflation.
Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.
— Ronald Reagan, former president of USA
IF THERE is one thing that consumers, investors, companies, and governments fear alike, it is inflation. As it goes out of control, it can become the greatest value destroyers of all. Inflation is the phenomenon where prices rise and money’s worth declines. As inflation soars, long-term investing can end up being a fruitless exercise.
While it is clear that in an inflationary environment, bonds do poorly, the link between inflation and equity returns is not so straightforward. A number of experts propound investing in equities as a certain way of beating inflation. When inflation rises, equities also rise because a company’s revenue or asset value would go up, along with inflation.
However, this theory is only partially true as a lot actually depends on companies’ ability to pass on the cost of inflation to consumers and in ensuring that there is no demand destruction. Historical evidence is mixed with some periods of inflation showing corporate earnings growth while in others earnings suffered.
While high inflation is not new to India, it is now becoming a more global phenomenon. In India, the Reserve Bank of India has already raised policy rates eight times in the past 12 months in its efforts to rein in inflation, which continues to stay above the central bank’s comfort level. Experts expect the RBI to hike its repo and reverse repo rates by another 50-75 basis points before inflation can be tackled in the real sense.
Looking at commodity prices, particularly crude oil, global outlook on inflation doesn’t appear too benign for the near future.
It is also argued that it is not inflation per se that impacts corporate earnings growth, but tightening of money supply that follows. India has already done it and all over the world, be it China, Europe, or the US, we see central banks talking of interest rate hikes.
Against this background, it makes sense for retail investors to look for ways to make their portfolios inflation-proof. ET Intelligence Group presents eight key themes for equity investors that can potentially shield their assets from the deadly fangs of inflation. PRESENT AND FUTURE OPTIONS
To face the inflation woes, the intuitive reaction is always to invest in gold, which has become very easy now, thanks to gold ETFs. Silver ETFs, which are yet to be launched in domestic markets, could also be an extra option for the future. However, investments in precious metals are criticised as being unproductive and sufficient barely to compensate inflation. While a part of one’s portfolio can surely be invested in gold — physical or ETF — relying solely on it to beat inflation is inadvisable.
Mutual fund schemes designed to invest specifically in commodity companies could also be a good option to best the inflation. However, there aren’t many such Indian companies and the only alternatives available are a handful of MF schemes that invest in global markets — either directly or through foreign funds (fund-of-fund) route. The performance of these funds has been superior of late, in spite of their lack of popularity. Investors can take exposure, but only after considering the currency risks involved.
BEST TO AVOID
It is not what you bought, but what you didn’t buy that decides returns on your investments in turbulent times. Hence, one needs to beware of industries more susceptible to high inflation. Interest rate-sensitive industries such as banks and NBFCs, real estate and auto top the list. EPC contractors with lumpsum contracts also see their margins squeezed as commodity prices go up. Companies that don’t have pricing freedom such as IOC, BPCL, HPCL are best avoided. Industries depending on discretionary spending such as aviation and hospitality also won’t be favourites if inflation is high. Companies with low value-added products such as most chemical players will also face some margin pressure
All market prices and related data as on 31st March 2011 CMP: Current Market Price, M-Cap: Market Capitalisation, OPM: Operating Profit Margin for trailing 12 months, P/E: Price to earnings ratio
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