One of the primary motivators of equity investment is the extra returns one might generate over traditional saving accounts or fixed deposits. But an additional motivator that increases the incentives to look for higher returns is inflation. This inflation eats away the value of your money, where every year it is worthless over the previous year.
In such a scenario, understanding different types of equity that perform well during high inflation periods is exceptionally crucial.
Real Growth vs Inflation
The increase in the prices of commodities and services in a country where, say, a product or service that cost Rs. 100 last year now costs Rs. 120 is Inflation. Therefore, real growth in wealth is defined as growth in a portfolio after accounting for inflation. When simplified, it means a person can now purchase more goods and services than last year, even after the inflation. Hence in economics terms, he is better off compared to last year.
For an investor, there is a constant tussle between the two fronts of investment decisions. An investor searches for the avenues for maximum growth with the least risks while ensuring the returns are still higher than the rate at which inflation eats away your wealth. In such scenarios, an investor needs to make an additional level in determining which types of equity shares to invest in.
Best Performing Sectors during inflation
The types of equity in inflation that can outperform during periods of high inflation can be tricky to identify. Periods with inflation tend to inhibit the increase of the value of growth stocks, but the sectors where one can still invest to hedges against inflation are:
Companies operating in Real Estates space have traditionally always performed above average during periods of high inflation. An investor can expect high returns because rising prices also contribute to the higher value received on resale in the future. Rental income through investment in REIT also is an excellent way to ensure return on your investment in periods of inflation where the rent a tenant pays also increases over time.
According to Wells Fargo, IBD, S&P Global Market Intelligence report, after 2000, during high inflation, Oil has generated over 41% returns among the asset classes. Prices of commodities like Oil and coal have a high degree of correlation with inflation, such as:
- The agricultural sector and Manufacturing sectors are heavily reliant on oil and coal to produce and manufacture their goods. Any increase in prices decreases their bottom line, thus leading to increased inflation.
- Additionally, as energy commodities prices increase, the logistics sector prices dependent on Oil or Coal to transport goods from place of production to consumption rises as well. This situation ultimately leads to the rise in prices of every good and service.
As our societies are currently still heavily reliant on Oil and Coal for much of their energy needs. Companies working in the energy sectors have been popular with an investor looking to hedge their capital during the period of high inflation
SImilarly to Oil, Gold as a commodity also tends to outperform during periods of high inflation. For years, gold has been the go to bet that acts as a hedge. Investors tend to buy gold in periods of high inflation, causing its prices to rise in international markets. At the same time, an individual can buy gold directly. From an equity point of view, they can also invest in Gold ETFs or Mutual Funds that invest solely in gold.
During periods of inflation, individuals tend to cut down on their luxuries, including eating out, holidays, and entertainment. But companies working in the FMCG sector are part of the everyday staple of the population. These companies work on a low margin, high volume business model. Thus an increase in prices of raw goods is directly passed on to the consumer, and the companies’ revenues stay relatively the same.
Furthermore, it is also seen that during periods of inflation, as people shift their expenses from luxuries, their consumption of the everyday grocery tends to increase. When considering these points, every investor tends to have a few companies from this sector within their portfolio.
Importance of Inflation when Investing
The cost and balances must be taken to minimize any unsystematic risk against the portfolio for any investment strategy. The benefit of investing accounting for inflation are:
- It preserves the value of the investor portfolio
- It allows an investor to diversify their portfolios
- It keeps portfolio buying power relatively constant
Inflation has long term social and economic effects, which is not apparent at the first go. Though there may be no guarantee, it is possible to see a higher level of returns even in periods of high inflation. But it is highly crucial to be proactive and regularly readjust your portfolio to account for the varying level of inflation.