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Navigating rising inflation

Felicity Thomas, Shaw & Partners

The key concern investors have currently is inflation. The reason they are concerned is because rising inflationary pressures could force long-term interest rates higher and potentially pull share prices lower.

To add further fuel to the fire, investors face the prospect that their bond holdings won’t counterbalance any losses in their equity investments. In the current inflationary environment, where rates are expected to rise by 2023 (or 2022 according to some economists) it tends to leave investors with limited options to look for yield. 

Headline inflation in the US was roughly 6.2 per cent for the year to October. This is the highest rate they have seen in three decades. If we continue to see elevated commodity prices, we will potentially see inflation above 7.5 per cent in the early part of next year in the United States. 

It will be hard for centrals banks to keep interest rates at zero and continue printing money and buying bonds when headline inflation is at these heights. 

We don’t believe it’s time to panic as we aren’t seeing hyperinflation as we have previously seen in Germany or Zimbabwe. However, most indicators are saying that the era of low interest rates and low inflation is over. 

Central banks worldwide have been very accommodative, printing money, reducing interest rates, and implementing quantitative easing (a former of monetary policy). A lot of this money has ended up in consumers’ bank accounts. 

If you look at the global household deposits from February 2019 to now, the increase is approximately $5 trillion dollars. This means we are now looking at 5% of GDP sitting in bank accounts that wasn’t there prior to the pandemic, which is positive for markets and positive for consumption. 

Shaw & Partners’ chief investment officer, Martin Crabb, said: “The implication for the equity market is that the Price Earnings (PE) ratios we are currently seeing - about 17.5 for the market as a whole - are unlikely to push too much higher in a rising interest rate environment”. However, he also said that “you need to come back to the earnings side, which is much, much more important in the longer term.” He added that “equity prices are driven by earnings in the long term but they’re driven by sentiment and risk in the short term.  The outlook for earnings continues to be positive”. 

He did warn that that Europe and Australia were likely to see slower growth next year due to a slowing China. So, one way he is countering this is by increasing positions in the following sectors: energy, gold and global financials. 

I still really like technology as a sector as there are many high-growth tech companies that can raise their prices as inflation rises. I am not taking the view that you need to rotate 100% out of technology stocks - you just need to have the RIGHT tech companies in your portfolio that are disruptors, have momentum and revenue growth. 

It is also important to note that capital is currently very easy to raise for small to mid-cap stocks providing great growth opportunities. This area continues to look very interesting, in my opinion.

Importance of Portfolio Reviews 

Candice Bourke, Shaw & Partners 

Regular portfolio reviews are prudent to ensure that your overall investment strategy remains relevant and appropriate in helping to achieve your goals and objectives. A key part of reviewing your investment portfolio is assessing your overall asset allocation to ensure it is well balanced and in line with your investment needs and wants. 

Think of it another way: investment portfolios are like cars. They need to be routinely checked and serviced on a regular basis. Car parts may need to be replaced from time to time. We advocate a similar approach when investors review their investment strategy and portfolio.

We have developed a few key questions to help you review your investment strategy and share portfolio in 2022, on your own or with your financial adviser: 

  • What are my top three investment goals and objectives? For example, are you trying to save for a house deposit?
  • What are my short, medium and long-term goals? 
  • Do my current investments suit my current goals? For example, given the current low interest rate environment, if you are invested mainly in cash earning sub 2% interest, is this return meeting your basic needs, goals and wants? 
  • What level of risk am I comfortable with? For example, how would I feel if in one year, my portfolio fell by -35% but the following year returned +50%?
  • What is my ideal target return? In dollar or % terms.
  • What is my asset allocation and portfolio mix looking like? 
  • Am I overweight or more exposed to a certain asset class such as global shares? 
  • Do I rely upon the income generated from my investment portfolio? This could include your retirement income needs. 

The above questions will help you and your financial adviser identify the best investment strategy, risk profile, asset allocation and advice to keep you on track to achieving your goals. 

 

What is an Asset Class?

An asset class is a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulations. 

Asset classes are made up of instruments which often behave similarly to one another in the marketplace. The three main asset classes are equities, fixed income and cash. 

Investment portfolios can also include listed and unlisted real estate, commodities, derivatives, unlisted private equity or venture capital investment opportunities and bonds. Investment assets include both tangible and intangible instruments that investors buy and sell to generate additional income or wealth on either a short-term or long-term basis. Each asset class is expected to reflect different risk and return investment characteristics and perform differently in any given market environment. 

The more risk you are willing to take on, the more you are likely to be rewarded with a higher return - but you are also subject to a higher probability of downside risks. 

Different asset classes have different income expectations, cash flow streams, varying degrees of risk and expected returns and performance. By investing across a range of asset classes and market sectors, you are spreading your portfolio risk and creating diversification which reduces risk and increases your probability of making a return. As the saying goes:  "don't put your eggs in one basket". 

Where do Ultra High Net Worth Invest?

Jason Phillips, Shaw & Partners

By definition, an Ultra High New Worth (UHNW) investor is a person or entity that has more than $30 million in investable assets. There are more than 3,000 Australians that fit within this category. Australia is forecast to have one of the highest rates of growth in UHNW populations globally over the next five years.

Having this sort of investable assets allows them to look at alternative investments that are not generally available to the retail investor.

We have observed a growing interest in the following categories of alternative investments:

  • Private equity and venture capital
  • Corporate bonds
  • Margin lending


Private Equity and Venture Capital

Private equity is where capital is invested in a company or an entity that is not publicly listed or traded and venture capital firms predominately invest in start-ups or the early stages of business. You may see crossovers between these two categories.

The reason why UHNWs invest in the above asset classes is that they can offer very significant returns, but they do have their fair share of risks. 

For one, the investments are illiquid and often have associated entry and exit fees. Since the investment could be anything from a couple of hundred thousand dollars to millions, they require extensive due diligence. 

When investing in such markets, UHNWs often turn to their trusted financial advisers as they can provide a preferential access to deals and entrepreneurs. Identifying such private investments with appropriate risk mitigation strategies like diversification can deliver higher returns than public markets.


Corporate Bonds

A corporate bond is a debt security issued by a corporation in order to raise finance for the growth of that business. As the investor, you are effectively lending money to the company at an agreed coupon and maturity date. These bonds can also be traded in the secondary market.

The reason why UHNWs invest in corporate bonds is that the yield can be significantly higher, but this all depends on the company’s credit rating. The yield is positively related to the inherent risk of the security and if the company cannot meet its debt obligations, the invested principal is at risk. 

Therefore, a company with good credit would pay a lower yield compared to one that is not considered investment grade.


Margin Lending

Margin lending is a loan that is secured by assets such as shares, managed funds, bonds and cash as security.

The reason why UHNWs use margin lending is because it allows them to potentially enhance the return of their current assets by borrowing funds and investing them in other shares or asset classes. This enables them to make their money work harder for them. As we are in a low interest rate environment, borrowing rates are at all-time lows and some UHNWs take advantage of this and invest in other opportunities that generate significant multi-fold returns compared to their borrowing cost. 

UHNWs understand the different risks associated with the above categories and generally have a higher risk appetite than retail investors. The trade-off between risk and return is that the greater the risk the higher the potential return.

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