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Sunday, December 5, 2010

Five investment ideas to beat inflation

Shooting well past the 5 per cent mark, inflation could pose the biggest risk yet to your plans of buying a home or living well on retirement. And with traditional investment options struggling to beat inflation, it's time to look at alternatives for your long-term portfolio, says Aarati Krishnan.

For most of us, inflation only conjures up images of sky-rocketing onion or milk prices that can throw the household budget into disarray. But have you thought about the serious damage that inflation can inflict upon your long-term wealth? Even a small but sustained increase in inflation rates can completely wreck your carefully constructed plans for buying a home, funding your daughter's engineering degree or even living it up after retirement (See table). Prepare for 8 per cent
The risk of inflation upsetting your financial plans is not theoretical; it is very real, for two reasons. One, inflation in India is usually discussed in terms of the Wholesale Price Index or WPI, which captures product prices at the factory level. But it is the Consumer Price Index (CPI Industrial Workers) that better reflects products and services used by middle-class consumers. Annual inflation in the CPI (8 per cent) has consistently stayed well above WPI (6 per cent) in the last five years. Two, inflation has climbed steadily in recent years, with a rising middle-class stoking demand for everything from apartment blocks to vegetables. Therefore, while financial advisors in India have traditionally used a 5 per cent inflation rate to construct long-term investment plans, inflation today is already at twice that level. So what inflation rate should investors budget for over the next decade or so?
A study of inflation trends over the past 30 years shows that 8 per cent would be a realistic number. Studying 30-year data for CPI (using ten-year rolling returns) reveals that consumer prices rose at over 8 per cent annually almost sixty per cent of the time since 1980. Inflation stayed at 5 per cent or less only five per cent of the time. If inflation itself is to reduce the value of money by 8 per cent every year, how should you rejig your portfolio to keep ahead of it? Here are five ideas that may help investors win the battle against inflation:
Stop shunning stocks
Whether inflation hurts or actually helps stock prices has been the subject of a wide academic debate. However, a study of real-life trends in the Indian stock market shows that stocks are the only asset class that have done a decent job of delivering ‘inflation-plus' returns to their investors, with any degree of consistency, over the last 30 years.
A rolling-return analysis of the BSE Sensex vis-à-vis the consumer price index shows that for investors who held on for ten years at a time, the BSE Sensex beat the consumer price index on nearly 80 per cent of the occasions.
Yes, there were certain ten-year periods (for instance, between 1992-93 and 2002-03) where stocks actually declined and left investors high and dry. But the big gains notched up in the good years would still have left investors in a comfortable position had they waited a couple of years to cash out.
In contrast, gold, the retail favourite did not match inflation nearly 50 per cent of the time! Investors who bought gold for the extended period between 1987 and 1995 would have found the value of gold holdings not keeping pace with inflation rates over the next ten years. In recent years, however, gold has done a splendid job of beating inflation, thanks to the spurt in returns on the yellow metal. Fixed deposits, where most people park the bulk of their savings, have not delivered positive ‘real' returns on most occasions.

All this suggests that stocks are a must-have in the portfolio for anyone saving money towards any 10-year plus financial goal. For a person with a debt-only portfolio earning a return of 8 per cent now, allocating 20 per cent to stocks may lift returns to a respectable 10 per cent, assuming stocks deliver 16 per cent over the next ten years. Beating inflation by a bigger margin will require a bigger stock component.
Debt-plus funds
Those not comfortable dabbling directly in stocks can take the mutual fund route. Monthly income plans that add a dash (15-20 per cent) of equity to a debt portfolio are one option. However, only a handful of them have trounced inflation over the past five years — the category as a whole has managed a 8.4 per cent return. Reliance Monthly Income Plan, CanRobeco Monthly Income and HDFC Monthly Income Plan are a few funds that registered a 11-12 per cent annual return.
Though they come with higher risk, balanced funds (which use a 65:35 combination of equity and debt) seem a much better option for conservative investors seeking to beat inflation.
One, all of the 15 balanced funds that have a ten-year record have comfortably beaten a 9 per cent inflation rate, their returns ranges between 13 and 27 per cent and averaged 17 per cent for ten years.
Two, returns from balanced funds, as they are treated as ‘equity-oriented funds', suffer lower tax compared to monthly income plans. Thus they may yield higher effective returns for investors in the higher tax slabs. Yes, balanced funds will see their values plummet in any stock market meltdown. But regulated equity exposures and a 10-year plus holding period should mitigate this risk to a good extent.
Real estate & rents
Though there is no ‘property index' to support this, inflationary periods in India have usually been accompanied by rising prices of real estate. Real estate investments help you keep ahead of inflation in two ways. One, as a home tops the ‘must-buy' list for most Indian salary-earners, property prices usually move in step with income levels (a key inflation driver) over the long term.
Two, rents on residential property, especially in the cities, also tend to march with inflation. Therefore, owning a second home and renting it out, ensures that a portion of your monthly income is automatically benchmarked to inflation over the next decade or so.
Most Indians already have a sizeable portion of their wealth locked up in property, thanks to the value of their own homes. A self-occupied home allows the owner to protect himself against inflation in his monthly rent outgo. However, those who have little or no investments in property should actively consider real estate investing to counteract the impact of inflation.
Buying plots of land, an affordable home in the suburbs or real estate funds to participate in property price appreciation are options. However, investors keep tabs of their overall portfolio structure while doing this — having over 50 per cent of your total wealth invested in property would be tantamount to putting all your eggs in one basket!
Make use of leverage
Ever thought about why the EMI (equated monthly instalment) on the flat you bought five years ago seems so manageable today? That's because of inflation too. One of the key side-effects of inflation is that, by steadily nibbling away at the value of a rupee, it puts the borrower at a distinct advantage over the saver in the long run.
The EMI of Rs 30,000 a month on the home loan you took five years ago may have amounted to 50 per cent of your monthly salary in 2005. But if your salary itself has kept pace with inflation (growing at 8 per cent a year), then you would today be shelling out only one-third of your monthly salary as loan repayment. The appreciation in the market price of your home would also have increased your comfort levels in paying off your debt.
Yes, higher inflation may push up the interest rates if you have a floating rate home loan. However, the tax incentives on home loan repayments, on top of the relatively low interest rates on home loans, still make leverage a particularly good option to fund your property purchases.
Now, we are not suggesting that maxing out your credit card while shopping or borrowing to bet on IPOs is an inflation-beating idea! However, judicious use of loans to fund long-term goals such as acquiring a degree or purchasing property does help you win the battle against inflation.
Stock up to win the inflation battle When it comes to beating inflation, all stocks are not equal. The following points may help investors choose stocks that can inflation-proof their portfolio.
Stick to blue-chips: Though mid-cap stocks tend to deliver bigger returns than large caps in a bull market, mid-sized companies in India have historically proved more vulnerable to rising raw material prices than large ones. That makes them less well-placed to deliver profit growth in high inflation scenarios. For instance, the Sensex companies in India have traditionally enjoyed over twice the profit margins of their mid-sized peers, given their market leadership, procurement strengths and pricing power. Thus, investors looking to add a stock component to their mainly-bond portfolios may add Sensex/Nifty ETFs or funds to get the equity exposure.
Lean towards commodity processors: A scenario of high global inflation usually puts commodity processors (like Tata Steel or a Hindalco) at an advantage over converters of commodities (like a Welspun Gujarat or an Apollo Tyres).
The former benefit from high commodity prices while the latter usually lose.
Look for pricing power: A high inflation scenario usually forces companies to look for avenues to pass on higher input costs to their customers without hurting demand. Companies that have high pricing power usually hold a monopoly or dominant market shares in their category, operate in niche markets or offer premium products that are in high demand.
In recent times, companies that market products directly to consumers (consumer durable and auto makers) have enjoyed good pricing power even in an inflationary scenario, owing to strong consumer demand.
Industrial product makers who sell to other businesses have been forced to absorb higher costs. A company's operating profit margins are the best test of pricing power.

Note: This article came in Hindu Business Line on 5th december 2010.I personally thank the author and sharing his views to visitors of my blog.Since this article can be mailed to friends publishing this in my blog is allowed as per copyright act.


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