Financial planners discuss their inflation hedges
Inflation fighting assets include commodities, defensive retailers and those companies able to pass along rising prices.
Some financial planners are suggesting investors pare back growth stock exposure and consider diversifying into inflation beneficiaries like commodities, supermarkets and bank hybrids.
Precious metals, oil, iron ore and other commodities generally perform well through periods of rising inflation, according to Shane Langham, senior private wealth adviser with Sequoia Wealth Management. Sectors such as utilities and real estate investment trusts, where revenues are often linked to inflation, are another way to buffer against higher prices, he adds.
“Hard assets like commodities performed very well, if not the best, of the different asset classes during the 1970s high inflation and high interest-rate period. Clearly, stocks which produce these commodities should also see outperformance,” says Langham.
“Having a closer look at these commodities and commodity stocks will certainly be well worth your time.”
Investors are searching for inflation safe havens amid a global selloff in risk assets triggered in part by aggressive central bank rate hikes. Technology shares are among the worst hit and the flagship Nasdaq Composite notched its seventh week of declines last Friday, the worst run since the dotcom bubble of 2001. Part insulated by the boom in commodity prices, the local S&P/ASX 200 is down 5.9% year to date.
Many fear the market bottom is a way off as inflation continues to break records in the US and Australia. The Reserve Bank all but assured investors more hikes would follow when it raised rates in May. Forecasters and traders see rates reaching somewhere between 1.5% and 2.5 by December. US Federal Reserve chairman Jerome Powell warned last week the US could feel "some pain" as the bank works to rein in price growth hovering at 40-year highs.
“I don’t like being bearish, I don’t like it at all,” said Morningstar head of equity research Peter Warnes in an interview last week. “I’m just being a realist. No use painting a picture for optimism if every colour in the palette is dark.”
Energy, supermarkets and hybrids
Scott Keeley, a senior financial adviser with Wakefield Partners, says rising prices for groceries and fuel should benefit supermarkets and other food retailers as well as energy companies.
“The ongoing need for food and energy make shares in companies in these sectors more likely to outperform in periods of high inflation,” says Keeley.
The energy sector is a rare splash of green on bourses around the world this year. After underperforming the broader index for years, the S&P/ASX 200 Energy is up 21% year to date. Despite the runup, energy remains the second most undervalued local sector under Morningstar coverage after technology.
Other assets that can also help protect against inflation include hybrid instruments issued by the big banks, says Felicity Thomas, senior private wealth adviser with Shaw & Partners.
Hybrids are part bond, part share. Usually paying a fixed interest rate like a bond, they can be converted into shares by the lender, potentially at a loss to the holder.
“In the current climate, we are tilting our clients’ asset allocation towards listed hybrid securities to provide a more defensive positioning in our clients’ portfolios with significant upside in a rising rate environment,” she says.
“The ASX listed hybrid securities is an asset class that has performed as a good buffer to equities amidst rising interest rates and bond yields … while they contain some features of equity and some features of debt, hybrids exhibit far lower capital price volatility than bank shares. They normally pay a regular quarterly, floating rate distribution,” she says.
Keeley has mixed feeling about gold, the archetypal inflation hedge. Investors need to balance the asset’s strong performance during particular periods of inflation against its lack of income.
“Gold is also often a beneficiary of high inflation, however, the inclusion of gold into portfolios needs to be considered holistically. While it might provide an inflation hedge, it provides no income return at all,” he says.