Sunday, February 27, 2011

Hedging against inflation

Inflation is a growing concern for many of us: It doesn't just make our day-to-day lives increasingly expensive but also quietly and relentlessly erodes our life savings.

It is vital to hedge against the dwindling value of our savings and fortunately there are asset classes that potentially do well under inflationary conditions.

Inflation hit a 26-month high of 5.5 per cent last month on the back of rising transport, housing and food prices, easily exceeding the 4.6 per cent rate in December and 3.8 per cent in November last year.

The Government has revised the inflation forecast for the year to 3 to 4 per cent from 2 to 3 per cent.

Mr Victor Wong, director of wealth management at Financial Alliance, expects inflationary pressures to remain high in the short term.

The outlook is not rosy, particularly with oil prices soaring because of the political unrest in the Arab region and rising food prices.

'We are likely to see increasing inflationary pressures in the quarters and years to come,' said Mr Brent Smith, chief investment officer and portfolio manager at Franklin Templeton Multi-Asset Strategies.

Asset allocation

Against an inflationary backdrop, financial advisers have an important role to play when working out the optimal mix of assets in customers' portfolios with their financial goals in mind.

Spreading your investments across different asset classes helps to reduce the overall risk to your portfolio, said Allianz Global Investors.

With portfolio diversification, gains from asset classes that are performing well will help to offset potential downside from those that are underperforming.

Mr Christopher Tan, chief executive at wealth management firm Providend, said: 'Asset allocation is important because by combining different asset classes with different risk and return characteristics that correlate to each other differently, we can create different portfolios that are suitable for different investors' risk appetites.

'By doing so, investors have a better chance of riding through the volatilities of the markets and getting the returns they need.'

Investors are typically advised to review their investment portfolios at least once a year.

One reason is that returns from assets tend to be unstable through time. This means that what does best in one year is not often the best performer in the following year.

This is because they perform very differently in various phases of the business cycle and inflationary environments.

For example, Mr Smith pointed out that US equities have performed 15per cent better in low inflationary environments than in times of high inflation from 1980 on.

So careful consideration and identification of such cycles is important if you are to manage allocations of your assets.

'If one can identify changing regimes and tilt portfolio allocations accordingly, there is an opportunity to increase overall portfolio returns or reduce portfolio risk (or both),' said Mr Smith.

Inflation hedgers

Financial experts say commodity-related investments, inflation-linked bonds and real estate can all help hedge against inflation.

Mr Tan notes that inflation makes commodities and real estate more expensive, so these are assets that will do well.

Inflation-linked bonds are indexed to inflation in order to protect investors from the negative effects of rising prices but there are few available in Asia.

Allianz says such bonds are usually issued by developed countries such as Canada, Japan, the US and a wide range of European nations and where there are specific funds to invest in them.

Commodities and equities generally tend to outperform bonds and cash under moderate and rising inflationary conditions, notes Mr Smith.

In higher inflationary periods, commodities and commodity-related equities such as gold, metals, mining and agricultural investments perform best, as do emerging market equities after taking the effect of inflation into account.

Gold rose 29 per cent last year, surpassing US$1,400 an ounce.

In recent months, interest in acquiring physical gold has risen as inflation concerns grip many South- east Asian economies.

A recent Friends Provident International survey indicated that gold is the most popular asset among Singaporean, Hong Kong and Middle Eastern investors.

Allianz says there are two types of commodity-related strategies to consider. The first involves investing in stocks of commodity companies as these have a close correlation to movements in commodity markets.

One approach could be to search out firms in the agricultural sector.

These would include those in production, processing and distribution, spanning the entire food supply chain, from farm to dinner table.

Another approach would be to invest in companies active in the mining and production of hard commodities like copper, zinc and gold. Such stocks tend to also benefit from rising metal prices.

The second strategy involves investing in derivatives linked to the commodity markets such as swaps and futures. Some investors like such funds because they offer the most direct exposure to commodity prices while equities may not offer pure exposure to certain products like cotton and cocoa.

Here are three commodity-related funds that might meet your investment strategy.

The Castlestone gold and precious metal funds are available only to accredited investors except if bought as part of an investment-linked insurance product at certain distributors.

The Barclays agricultural fund is available to retail investors here.

There is a one-time sales charge of up to 5 per cent for the three funds.

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