As investors grapple with the current environment of low economic growth, high inflation (a situation known as stagflation) as well as tightening monetary and fiscal policy along with geopolitical risks, a diversified investment portfolio can work as a hedge against inflation, according to Datt Capital, an active equities boutique investment manager.
Emanuel Datt, Chief Investment Officer, Datt Capital says: “One of the best things investors can do is to put more onus on tangible, hard assets versus the recent popularity (and erstwhile success) on investing in abstractions. In these adverse market conditions, we believe that its prudent to get back to the basics.
“Accordingly, factors such as positive cashflow, positive real returns (post-inflation), relatively low valuation multiples, returns to shareholders via capital initiatives and strong market leadership positions can be viewed favourably.”
Which bring us to our next question: which asset classes will be resilient in this investment cycle?
“We can use history as a guide to compare similar environments in the past with the present day. The stagflationary environment in the 1970s is a reasonable comparison in some ways to the present day, with numerous ‘oil shocks’ experienced analogous with the global ‘energy molecule’ crisis being experienced today.
“The sector that experienced the best returns over this decade was the energy sector, with the worst returns coming from the technology sector. Value and small cap assets performed best throughout the decade, with growth assets and government bonds providing the worst relative returns,” notes Datt.
“Accordingly, we believe the most favoured sectors to be going forward to be:
- energy – unpopular and cheap due to ESG mandates with material operational leverage to higher energy prices going forward
- agriculture – defensive, real asset class, albeit with typically lower returns
- tangible goods and commodity producers – will benefit from the trend towards greater localisation and the unwinding of globalisation.
“It’s important to observe that recent inflation has been driven by shortages and supply chain disruptions. Rising rates are unlikely to control inflation in the short term. Inflation has been labeled the ‘silent tax’ as it essentially measures the fall in a currency’s purchasing power. It reduces the standard of living for the majority, which has the knock-on effect of reducing economic activity and increasing the probability of a recession.”
Datt adds: “We believe it’s imperative to invest with those stewards of capital that can outperform the rate of inflation earning a real rate of return, thereby preserving one’s purchasing power and quality of life.
“Passive market exposure may not provide this. However, we are firmly of the belief that the appropriate actively managed funds in combination with other uncorrelated assets provides a higher probability of preserving an investors’ wealth in real terms.”
Since August 2018, the ASX200 Total Return index has compounded at an annualised rate of 8.79% per annum. Over the same timeframe, as an example, the Datt Capital Absolute Return Fund has doubled the index return: achieving 17.73% per annum[1] at lower relative risk, despite some of the most turbulent markets in living memory.
He notes: “This demonstrates the importance and value of adding high performing, active managers as part of a diversified portfolio as a potential hedge against inflation.”
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