Monday, July 11, 2016 9:00am / Uchenna Ndimele*
The June 2016 consumer price index (CPI) released indicates that inflation in Nigeria is not only alive and well, it is growing. This is not a good news for investors generally and retirees in particular. It is also not a good news for those fixed income earners whose sources of income have no means of being adjusted for inflation. It is not unlikely that many investors are pondering over the numbers asking the question, “how do I beat this inflation”. It may not be possible to beat inflation 100% but it may be possible to hedge against it with well thought out investment plans and strategies. Besides using real estates (which most times involve huge cost), investors may be able to position their portfolio in a way that will insulate them from the devastations of inflation. Here are some noteworthy strategies:
Build a Portfolio of Mutual Funds
One way to beat inflation is to build a portfolio of mutual funds by selecting a combination of funds that can stand the test of time. One of the advantages of mutual funds is that they offer the benefits of diversification and professional management. By selecting funds with exposure to different categories and sectors of the economy, you build a diversified portfolio that will not only prove to be resilient in market turmoil but also weather the storm of inflation. Find the correlation between existing mutual funds and the Nigerian Stock Market using the Allshare index as a proxy, and correlation among mutual funds, and then select a mixture of mutual funds based on such correlation analysis. Correlation is the degree to which an investment moves with any other investment. By choosing asset classes which are not highly correlated with each other you design a winning portfolio that is not only diversified but enjoys a balance between risk and return.
Choose Growth Stocks
Growth stocks are those stocks of companies whose earnings grow at an above average rate relative to the market. The disadvantage is that growth stocks seldom pay dividends but rather reinvest such dividends in capital projects for better potential growth. Growth stocks enjoy market dominance, barrier to entry, and are characterized by accelerating earnings growth. They also record high profit margins as well as high revenue growth.
Invest in Stocks with High Dividend Yield
For those that are “allergic” to growth stocks because they are dividend investors, inflation can still be taken care of by investing in stocks with high dividend yield. By investing in such high dividend yielding stocks, the negative effects of dividend can be offset by the above inflation dividend yields. Unfortunately, no stock has generated a dividend yield that exceeds the rate of inflation this year. Here are the few stocks with double digit dividend yield as at July 2016
Invest in High Yield Bonds
Unfortunately, bonds tend to lose value in inflationary environments because bond prices move in opposite direction as interest rates, which in most cases rise as inflation rises. That notwithstanding, it makes a wise investment sense to diversify with bonds. In doing so, look for high yield bonds or high coupon bonds. If there are floating rate bonds available, look into such bonds especially when they float around the MPR rates. In some cases, such floaters may have floors and ceiling, so pay attention to such provisions. For example, the MPR+5.25 TOWER 9-SEP-2018, pays a coupon of 5.25% in addition to whatever the MPR is at the reset date, such that if MPR is at its current rate of 12%, this bond will pay 17.25%, which exceeds the prevailing rate of inflation. Since MPR is likely to rise with inflation, it means that investment in this bond and its type will be a good buffer against inflation. Below are the floaters currently in the Nigerian Market
Invest in Commodities:
Commodities have the reputation as a hedge against inflation but unfortunately Nigerian investors are not well exposed to commodities as an asset class. The main reason is largely due to lack of such tradableinstruments and limited exposure to foreign commodity exchanges and of course, the requisite knowledge to trade on such instruments. Thankfully, Nigerians can now invest in Gold via the New Gold Etf of Vetiva Asset Management Company. Gold has been known to be a good hedge against inflation. Currently, the New Gold Etf has recorded a 65% return YTD which is far more than the current rate of inflation in Nigeria, although it lost 3.59% last year after gaining 13,39% in 2014
Putting it all together
The summary of all I have been saying is that a portfolio comprising New Gold Etf, index linked bonds spiced with some growth stocks and one or more bond mutual funds will undoubtedly provide an antidote to inflation.
*Uchenna Ndimele is the President of Quantitative Financial Analytics Ltd