How to manage your portfolio in times of high inflation

A reduction in taxes may cool down fuel prices and banning exports may cool down prices of commodities. But that is not going to rein in spiralling prices, say experts. But the question is: how does inflation affect your portfolio?

Inflation: Is it here to stay?

Consumer price inflation (CPI) in India was recorded at 7.79 percent in April 2022, an 8-year high. Though inflation is a natural outcome of economic growth, high inflation can be detrimental in many ways.

Rising inflation reduces purchasing power, leading to a decline in demand for goods and services, thereby affecting economic growth and corporate earnings. To curb inflation, central banks typically raise interest rates. The Government, along with the Reserve Bank of India (RBI), has acted on containing inflation. While the RBI opted for an unscheduled 40-basis-point hike, the government decided to put in place the supply of some important commodities by reducing import duties, bringing in export limits, introducing export duties and also cutting taxes on fuels.

Despite these measures, however, experts do not see inflation turning benign. Rajeev Thakkar, CIO, PPFAS Mutual Fund, expects inflation numbers to remain elevated for six months to a year before subsiding.

In her recent research note issued on May 22, Pranjul Bhandari, Chief Economist, India, HSBC Securities & Capital Markets (India), says that measures such as excise duty cuts in petrol and diesel, higher subsidies and changes in select custom duties will only partly address the ongoing inflation problem, and that headline CPI will still likely average well above the RBI’s 6 percent upper tolerance limit in FY23.

Put simply, you have to amend your ways of investing money to earn respectable returns on your portfolio

Fixed income investing

Strong inflation is a threat to fixed income investors, as the real rates (nominal interest rates minus rate of inflation) are negative. Debt fund investors are getting hit due to spiralling yields. Short-duration debt funds and corporate debt funds, the two more popular categories among retail investors, offered 3.48 percent and 2.02 percent, respectively, in the 12 months to May 24, 2022, according to Value Research. The marked-to-market losses due to rising yields are far from over, as interest rates are expected to continue rising.

Bhandari expects the RBI to continue on the path of raising policy rates. “Following a 40 basis points increase in the repo rate in May, we expect another 40 basis points increase in the June meeting, taking the repo rate to 4.8 percent. Thereafter we expect the RBI to move to a series of lower quantum repo rate hikes of 25 basis points each, taking the repo rate to 6 percent by mid-2023,” she writes.

Chirag Mehta, Chief Investment Officer, Quantum Mutual Fund, sees liquid funds better positioned to benefit from the rising interest rate scenario. “Investors should consider shifting to duration products at a later date as the yields are expected to inch up further,” he adds.

If inflation remains sticky then yields may continue to spike, especially if the government intends to borrow large sums and its disinvestment targets are not met.

Amol Joshi, Founder of Mumbai-based Plan Rupee Investment Services, advises avoiding long-duration funds, especially constant maturity funds. “Instead allocate money to short duration and medium duration schemes offering roll down strategies,” he says.

Equities: Opportunity in volatility

While debt-laden companies will see heat as interest rates go up, investors may also want to stay away from loss-making companies as funding losses becomes tougher by raising capital in a volatile equity market.

Investors have to be very careful while allocating money to stocks. Chasing themes that did well in the past just because prices are down does not make sense.

“Companies with pricing power for their goods and services are not harmed much by inflation,” says Thakkar.

As interest rates rise and stock markets turn volatile investors will have an opportunity to build their portfolios. “In a high inflation scenario, sectors such as information technology, finance, and materials tend to do well. Also, companies that can pass on input cost prices are better investments in high inflationary times,” Mehta says.

Investors should ideally use large cap, flexicap or multi-cap funds as core holdings in their investment portfolios, while investing through mutual funds. Avoid thematic funds, if you do not have a view on them. Let you systematic investment plans continue. As the markets come down, the allocation to equities tends to go down. If it is below the desired level, you may want to invest more to make up for the under allocation.

Joshi advises investing in balanced advantage funds to benefit from volatility.

Gold

Experts are hopeful that gold should act as a strong portfolio constituent to defend against inflation and volatility.

“Persistent inflation and negative real interest rates make a strong case for holding on to gold in line with asset allocation, despite the weakness seen in gold prices in the recent past. In the case of a stagflation scenario — high inflation and low growth, gold prices tend to do well and offer support to the portfolio,” says Mehta.

BofA Securities, in a research note released on May 9, expects gold to trade at $1,957 per ounce in CY2022. Today, gold traded at $1,857 per ounce on the international market and at Rs 50,980 per 10 grams on the MCX exchange.

Gold should be bought through gold exchange traded funds, funds of funds investing into gold ETFs and sovereign gold bonds, subject to an overall allocation of 5-10 percent of the portfolio.