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Interest rates have gone up several times in the last few months as the Reserve Bank tries to minimize the impacts of inflation. The Reserve Bank meets six times a year to try and manage inflation, which in South Africa currently stands at 7.6%.
But what is inflation and why are we seeing an increase? ‘Inflation is simply how much a weighted basket of goods and services, such as groceries and petrol, goes up from one period to another. The changes are expressed in percentages, and since South Africa’s inflation target is between 3% and 6%, the Reserve Bank’s mandate is to maintain this target range.
‘The high inflation is due to several issues, but the main one is the rise in oil and agriculture commodity prices like wheat and sugar. This means that it costs more to transport goods and produce necessities such as food,’ explains Ester Ochse, product head, FNB Integrated Advice.
With prices going up what does that mean for your investments and what can you invest in to beat inflation? Options include gold, real estate, bonds and equities. We review the pros and cons of each.
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Going for gold
Gold is generally seen as an inflation hedge, mainly as it can retain value better than other asset classes and risky currencies when there’s much uncertainty in the world. But lately, gold’s performance has been inconsistent.
Faheema Adia equity analyst of Momentum Securities warns: ‘One drawback of investing in gold is that it does not yield any interest, therefore as interest rates go up investors look to other interest-bearing asset classes such as bonds to benefit from these higher rates, which explains why the price of gold has recently fallen.’
Debra Slabber, portfolio specialist director at Morningstar Investment Management SA, adds this asset should still not be overlooked. ‘There is a benefit to hold a small amount of gold in a portfolio from a diversification point of view. It hasn’t really stood the test as it normally would. But markets are different this year compared to the crash two years ago and a decade ago. There’s nothing wrong with holding a portion in gold.’
The name is bond…
Inflation linked bonds are typically a good hedge against inflation as the coupon payments are linked to inflation rates. ‘In South Africa you can’t buy these directly so you’d have to do that through a multi-asset income fund that would have a high asset allocation to inflation linked income bonds,” explains Slabber.
Government bonds are another consideration. ‘In South Africa, however, our credit rating has been downgraded over the years to below investment grade, which means SA government debt is not considered too safe and therefore demands higher yields than investment grade debt.
‘To mitigate some of this credit risk, we would advise investors to take exposure to shorter term SA bonds. The smaller investor has the option to invest in either RSA Retail bonds or in Bond Exchange traded funds. The advantage of Bond ETFs is that it is generally more liquid and allows investment of smaller amounts,’ explains Adia.
Safe as houses?
Property is generally a good investment during a high inflationary environment. ‘Property is generally a good investment to have amidst high levels of inflation as landlords can pass on increased costs related to inflation to tenants by way of rental increases. The value of property also tends to increase in high inflationary environments.’
Not all types of property should be considered. Adia adds: ‘We would recommend exposure to residential property or industrial property at this stage. We advise investors to, however, stay away from offices due to structural changes post covid, which have resulted in less demand for office space, as many companies have transitioned to allow employees to work from home.’
If you want to invest in property without exposing yourself too much to the drawbacks, you could consider Real Estate Investment Trusts (REITs). REITs are listed in the Johannesburg Stock Exchange (JSE) and other global markets.
‘REITS are our preference because these shares trade daily on a stock exchange and are therefore more liquid, which means investors can buy and sell it more easily at low transaction costs. REITs are also more accessible than private property ownership as investors can invest smaller amounts, without the hassles of having to manage the property themselves,’ says Adia.
Equities
For some it may be scary to consider the stockmarket as an inflation hedge, given the volatility we’ve seen in local and overseas stockmarkets. Adia points out that, to date, the JSE ALSI is down almost 14%, while the S&P is down around 23%. There are also concerns of a global slowdown and possible recession.
Adia says: ‘Given these concerns, in our view, investors should take a cautious approach to investing in equities for now. In the next 6-12 months, however, once interest rates peak and inflation levels come down, markets will likely start to show signs of recovery. At which stage there could be great opportunity to buy a broad variety of quality stocks at discount prices.
‘If you would like to have some exposure to equities right now, we would advise you to invest in defensive industries that are likely to fair better during difficult times. These industries include; non-discretionary consumer goods, health care and pharmaceuticals. Examples of companies we like in this space include Pick n Pay, Moderna (US), and Mr Price.’
