Careful to be careful with the use of leverage
Inflation has become one of the biggest global economic stories of 2022. Singapore is no exception, having recorded an overall inflation rate of 5.4% in March – its fastest pace since April 2012.
Recently, economists and policymakers have sounded the alarm of impending “stagflation”, a phenomenon that combines economic stagnation and inflation, raising concerns among investors as to whether there is a way to hedge against this risk. particular.
In an inflationary environment coupled with low interest rates, keeping cash in the bank earns virtually no interest, but prices continue to rise. This can lead to a decrease in purchasing power over time, especially if you are not invested.
When it comes to managing inflation risks within your portfolio, there can be various asset classes such as inflation-linked bonds, properties or commodities that can have a high correlation. with the inflation figures. However, when we look at a longer-term portfolio, equities are usually the heart and main driver of returns.
What most investors don’t realize is that equities can provide a good hedge against inflation risk within portfolios, with companies passing on price increases to end consumers which will eventually trickle down to profits. and stock prices.
However, spotting companies that could pass on such a cost hike is not easy as it requires significant due diligence on the part of investors.
To this end, investors seeking to manage information oversupply as well as understand the critical risks and rewards associated with a particular investment may find fund managers increasingly important, particularly when it comes to it’s about filtering out those high quality companies.
As we look at portfolio allocation strategies that can better manage inflation risks, we will also need to ensure that diversification is reflected in the medium to long-term investment horizon. One of the pitfalls that investors tend to fall into is falling into the “recency bias” trap where they invest in assets or strategies that have performed well in the recent past.
For example, most investors might have a portfolio with an overweight to growth or technology stocks due to their strong performance over the past decade.
However, sectors such as materials, energy and financials, which generally have a higher correlation with inflation, may be overlooked. These are also sectors that are generally cyclical in nature and are overweight in value strategies.
Therefore, it is important that a portfolio has a good balance between growth, value and quality stocks to ensure a consistent and sustainable investment return profile over the long term and to protect against inflation.
With growing concerns of potential stagflation, there is no need to panic at this time, but it is prudent for investors to be cautious with the use of leverage as it can incur costs and higher risks when interest rates rise.
• Elson Goh is Head of Asia Portfolio Management, St. James’s Place