Your money: Inflation-proof your investment portfolio

Rising prices are a major concern for everyone, from governments, companies, consumers and investors. In India, inflation started rising from September 2021 when it was 4.35%, reaching 6.01% in January 2022. This is an increase of about 50%. Inflation, if it gets out of control, is definitely costly for everyone. Although it is empirically clear that bond yields are not attractive in an inflationary trend, the relationship between inflation and equity returns is mixed. Thus, it is essential to draw the right strategies and build an investment portfolio in such a way that you will be able to overcome inflation or at least try to minimize its impact on your wealth creation project.

What is inflation?
Any economist would define inflation as nothing more than too much money behind too little. In other words, a rupee today will not buy a product of the same price for five years. Basically, inflation measures the average price level of a basket of goods and services in an economy over a period of time. There are many reasons for inflation. Reasonable reasons for the current rise in inflation in India are shocks to supply due to epidemics which disrupt production, high oil prices, rising production costs and so on.

Gold and Silver ETFs
Historically, gold has been considered a hedge against inflation. Indeed, many investors consider gold as an alternative currency, especially when losing the value of their own country’s currency. Gold is a real, physical asset, and for the most part holds its value. Silver, another precious metal, has many industrial values ​​(besides the use of ornaments) because it is an important component of electronics and emerging technology products. As far as investors are concerned, instead of buying gold in physical form, one can buy gold and silver exchange traded funds (ETFs).

Real Estate Investment Trust
The relationship between real estate and inflation is negative which means that when inflation is high, the value of property increases, and thus rents. One of the easiest ways to invest in real estate is through the Real Estate Investment Trust (REIT). A real estate investment trust is a company that owns and / or manages a variety of income-generating assets such as apartment buildings, commercial shopping complexes, hospitals, etc. However, investors should analyze REIT’s business model before investing because REITs are sensitive to interest rate movements.

Broad Market Index (BSE500):
Investing in equity stocks offers the most upside potential in the long run. In general, the businesses that benefit the most from inflation are those that are not heavy assets and require less capital. In contrast, businesses that deal with natural resources have a negative impact on inflation. Currently, information technology is the second most concentrated sector (14.44% in BSE 500). Generally, IT firms are not capital intensive and therefore, they should either win inflation or be less affected by inflation.

Consider alternative resource classes
Under this section one can consider real resources such as antiques, industries, etc., which can act as an inflation hedge. In general, the price and value of these collectibles will increase over time, which will exceed the rate of inflation. However, such resources are minimally liquid and one has to be careful not to end up buying a duplicate antique. Investors may also consider investing in selected hedge funds or startups through unlisted stocks, etc., which will reduce inflation. But this alternative asset class is not suitable for everyone and should be invested purely based on their risk profile and investment goals.

In conclusion, inflation is a normal phenomenon and a well-disciplined investor can deal with it by investing in the asset class discussed above to reduce inflation or reduce its impact on their wealth creation journey.

The author is a Professor in the Department of Finance and Accounting at IIM Tiruchirappalli

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