Inflation has always been a threat to investment portfolios but the recent surge in prices of everything from food and gas to housing and wages has advisors fielding more questions from clients about how it will impact their retirement savings.
Canada’s annual inflation rate jumped to 4.7 per cent in October, the highest since February 2003, while U.S. inflation rose 6.2 per cent last month, the biggest increase in more than 30 years.
“We have been relative inflationistas since the early spring – persistently warning of upside risks – but even we have been consistently surprised by the ferocity of inflation this year,” says Doug Porter, chief economist at BMO Capital Markets, in a recent note.
Supply chain issues are being blamed for rising costs and some economists believe the surge in inflation will be “transitory” (or temporary) until the kinks are smoothed out. Regardless, advisors are looking at ways to position clients’ portfolios to account for the higher costs that both consumers and companies are facing.
Laura Barclay, vice-president and senior portfolio manager at TD Wealth Private Investment Counsel in Markham, Ont., says a rising inflation environment is a good time to review asset allocation, and in particular, the level of fixed income in a portfolio compared to equities.
“I would be spending time [having] fulsome conversations about what their spending is going to look like,” she says.
“Tactically, we want to be overweight [in] equities [and] underweight bonds,” she adds, given that inflation is currently running higher than what fixed-income investments such as bonds and guaranteed investment certificates are paying.
The only reason some investors will want to be in bonds today, she says, is if the money needs to be spent in the near term, or if investors would sleep better at night not risking those funds in the stock market.
Opportunities in equities
For people who want to be in equities, she says the goal is to own companies that can benefit from passing on the higher costs.
“A great way to participate in the inflation trade that we’re seeing today is to be overweight in banks and industrials,” Ms. Barclay says.
She believes banks are a good holding because the companies will benefit from the anticipated increase in interest rates that often come with rising inflation. Meanwhile, industries, including commodities such as mining and energy, are benefiting from rising demand amid the economic recovery.
Companies in the service economy, such as restaurants and retailers, may be less attractive in a rising inflation environment because their costs are rising for both supplies and employee wages, she adds.
Bradley Eizenga, vice president and senior portfolio manager at BMO Nesbitt Burns Inc. in Windsor, Ont., says he likes to point out to clients that rising inflation doesn’t affect all assets in the same way.
In general, he says poorly capitalized companies with less cash flow will be less resilient in a rising-price environment, regardless of what sector they’re in.
“What you do about inflation in a portfolio is pay attention to your security selection,” he says.
“We love the strategy of owning shares of companies that make things or do things that we can’t live without because we think they’re resistant to almost everything,” he adds, citing examples such as Johnson & Johnson JNJ-N and Visa Inc. V-N, both of which he includes in clients’ portfolios.
Focus on the time horizon
The right investments will also depend on an investor’s time horizon, particularly as inflationary spikes tend to be a short-term occurrence.
Mr. Eizenga’s approach with clients, particularly those still saving for retirement, is to keep the long term in mind.
“When we build investment portfolios, we need to actually expect that economics are going to turn themselves upside down,” he says. “Occasionally, stock markets are going to sell off unexpectedly – and the strategy itself has to take that into account.”
Jason Del Vicario, portfolio manager and insurance advisor with the Hillside Wealth Management team at iA Private Wealth Inc. in Vancouver, a division of Industrial Alliance Securities Inc., says his team has chosen to “double down on things that we can control and ignore the things that we can’t,” such as inflation and interest rates.
His team’s strategy is to find companies that have high margins, little or no debt, a strong competitive advantage in their industry, and, last but not least, don’t need a lot of capital to maintain or grow their business.
For example, Mr. Del Vicario says he sold Amazon.com Inc. AMZN-Q earlier this year because of its ongoing requirement to have large chunks of warehouse space, robots, and people to run them. The proceeds went into two other technology stocks: Microsoft Corp. MSFT-Q and Facebook Inc., now called Meta Platforms Inc. FB-Q, which he says are much less capital intensive.
And while Meta has several costly legal and regulatory issues on its hands, he believes the outcome will likely make the company stronger and more competitive compared to its peers.
“Our strategy is to focus on companies that possess scarce intangible assets because we are confident that by the very nature of their scarcity, they have pricing power,” he says. “They don’t have a lot of input costs to generate their revenue and profits, which is the sweet spot for protecting your portfolio against inflation.”