by Kristia van Heerden, 21 November 2014
Over the past 10 years, inflation rose 6.1% per year. Between September 2004 and September 2014, the Consumer Price Index (CPI) rose by a total of 81%.
Unless your income also rose by 81% over the same period, odds are you’ve had to give up a few luxuries. You’ve probably also started saying things like, “In my day we only paid R4 for a litre of petrol!”
The CPI tracks the prices of consumer goods and services and is comprised of a number of sub-indices tracking items like food, petrol and services. Combined, they represent how much it costs to live in South Africa. Says Alex Funk, head of asset consulting at GCI Asset Management: “The average consumer considers inflation to be far more than the reported CPI figures and, to be perfectly honest, they are correct.”
For example, in August the CPI figure for food price inflation was 6.4%, while the registered inflation was 9.4% − a 3% inflation premium that hits local consumers where it hurts most.
Bleak though the inflation figures might be, there is still hope in the free market. The JSE All Share Index (Alsi) grew by 16.3% per year over the same period, representing a total growth of 353%. If you invested the equivalent of your monthly expenses in the Alsi every month for the past 10 years, you would probably be spending less time harking back to the good old days and more time drinking champagne.
With inflation tightening its grip on household budgets on the one hand and the JSE continuing to deliver great returns on the other, should your investment strategy place a greater focus on hedging against ordinary lifestyle expenses like food, clothing and education? Alwyn van der Merwe, director of investments at Sanlam Private Wealth, thinks so.
“The primary and generic reason for investing is to grow your purchasing power over time. In other words, to hedge against inflation,” he says. His colleague, investment analyst Renier de Bruyn, agrees, adding that inflation slowly erodes the purchasing power of cash savings.
“Hedging involves reducing the risk of adverse price movements in an asset, therefore taking an offsetting position in a related asset. Hedge investing therefore involves purchasing an asset to protect oneself against a rising cost. The closer the fit between the two, the better the hedge will be,” explains 2014 FPI Financial Planner of the Year Peter Hewett. He says that coupling lifestyle cost volatility to companies associated with that lifestyle is not a new concept.
“In 1987, the price of a one-carat diamond was $6 000. By 2014, the price had increased to $12 700, a 112% return over the period. If one had invested the same amount of money into Tiffany & Co. shares, it would be worth $312 500 in 2014, a return of over 5 000%. Who said a diamond was a girl’s best friend?” he jokes.
“Many investors find comfort in a strategy like this due to the psychological dynamics caused by the tangible link between an identified expense and the asset price offsetting it. It also creates discipline in the sense of long-term investing due to the underlying drivers of the two prices being more closely linked.
“If you are in a position to purchase a basket of shares across the many sectors and industries that directly and indirectly impact on the cost of living, this would possibly be a reasonable strategy because you would end up with a very diversified portfolio,” he adds.
Sonia du Plessis, a certified financial planner at Brenthurst Wealth management, says buying a stock to hedge against inflation is a good concept only if the company is a good one. “One has to look at the share itself. It needs to be able to add value and needs to be a good buy,” she explains. She adds that investing for a period of at least 10 to 15 years is imperative in creating a successful lifestyle hedge portfolio.
The dividend yield of most of the companies listed below beat inflation over the past 10 years, but De Bruyn warns that the dividends of these companies don’t always correlate perfectly with the underlying inflation.
“Nevertheless, I like the thinking because it forces investors to focus on the underlying cash flows of the companies, as opposed to just the share prices, and consider the impact of inflation on their savings.”
Not a perfect strategy
If past behaviour were a predictor of future behaviour, putting together a lifestyle hedge portfolio based purely on the dividend yield of these companies would be a no-brainer. Unfortunately − try as we may − nobody can predict the market and many therefore warn against this method of investment.
Hewitt says that the challenge lies in differentiating between multiple companies providing similar services. He agrees with Du Plessis that a better strategy is to invest in a quality company that is well-priced and hanging on to the investment over a period to capitalise on compounding. “Investing in quality businesses and giving them time to grow is a far superior strategy,” he says.
Funk finds the concept of a lifestyle hedge portfolio too simplistic. Firstly, he says, inflation pressures on companies such as Shoprite and Pick n Pay arise from producer inflation and is most often the result of the rising cost of raw materials. Because retailers avoid passing on these increases to consumers immediately for fear of losing customers, it could take over six months for the producer inflation to reflect in the spending of consumers.
“The use of such stocks as a hedge strategy would require the consumer to have a longer investment time frame. Ultimately, it will result in an imperfect hedge strategy as consumers will still have to fund the cost deficit for at least six months,” he says.
His second objection to the concept of a lifestyle hedge portfolio has to do with the complexity of a company’s share price. He says that factors like debt-to-equity ratios, operating expense analysis, director dealings, the role of management and corporate governance as well as the economic environment can have a material impact on the share price movement, not just price inflation.
“Thirdly, an extensive break-even analysis would have to be constructed to indicate the amount of shares needed to perfectly offset the rise of inflation and the effect it will have on the consumer’s monthly disposable income,” he adds.
The consumer would have to analyse her existing monthly disposable income at the current rate of inflation. An assumption would then have to be made on the expected inflation for a period of six months to a year, after which she would have to calculate to what extent the inflation increase would impact her current monthly disposable income.
Finally she would have to assess the assumed share price increase and number of shares required to match the decrease in monthly disposable income after considering all costs, including brokerage fees. This would have to be an exact match for the hedge strategy to be perfect.
“Consumers can benefit far more financially by creating an optimal retirement plan, sticking to the plan and investing assets in a broad range of asset classes, countries and asset managers, rather than trying to exploit complicated strategies to gain financial wealth,” he concludes.
Yusuf Wadee, head of Exchange Traded Products at RMB, says that investors have to take a long-term view and invest in a number of shares to get a better representation of the market.
“It is far less likely for a collection of shares to be affected by a bad set of individual company results,” he explains. “In addition, holding a basket of shares across a diverse set of companies is more likely, over time, to protect against inflation, which is measured over a broad basket of goods and services.”
He says other financial instruments, such as inflation-linked bonds, are more closely linked to CPI. “Holders of these bonds earn returns which are extremely close to inflation for the duration of their investment. These bonds are frequently used by professional investors to hedge out their future inflation-linked commitments and liabilities.”
He recommends products like RMB’s InflationX ETF, which are linked to the value of these bonds and perfect for investors looking for inflation-linked returns to hedge against their personal, and ever-increasing, cost of living.