Inflation Nation: BMO Asset Management's strategies to hedge against inflation
As inflationary pressures appear to not be abating anytime soon, it may be time to start investing in companies with "pricing power" to better protect your portfolio, and to watch out for exposure to rising rates, according to several portfolio managers.
With Statistics Canada revealing in November that inflation climbed to the highest rate in nearly two decades, Canadians are well aware that prices for many goods and services are elevated. But inflation can be good for some businesses, according to Denis Taillefer, portfolio manager at Caldwell Investment Management.
Equity investors just need to look for companies with pricing power; in other words, an ability able to pass on elevated costs without sacrificing profit, he said.
“We look for areas that have the ability to still grow their earnings in that [high inflation] environment,” said Taillefer, in an interview. “The key is looking for companies that have the ability to pass on those elevated costs through pricing power.”
“If you don’t have the ability to pass on these costs to your clients on the other end, we tend to stay away until the costs start to slip.”
His comments come after the Bank of Canada decided on Dec. 8 to keep interest rates steady at 0.25 per cent, while warning again that elevated consumer prices remain a key risk for the Canadian economy.
Taillefer said until consumer prices start to come down to the Canadian central bank’s two per cent target, the best strategy when considering adding to a portfolio is to consider segments where supply-and-demand dynamics won’t be disrupted.
“We have increased our energy exposure over the past six to 12 months,” he said. “For that simple reason, we find the supply-and-demand dynamics in that market are favourable to see some sustained price increases. We’re holding on to those positions.”
Martin Pelletier, senior portfolio manager at Wellington-Altus Private Counsel, agrees with Taillefer's perspective. He added that investors would do well by looking at what Alberta energy executives are doing.
“Oil company execs are paying down debt,” Pelletier said in an interview. “They’re taking advantage of these inflationary pressures and higher oil and gas prices to reduce debt instead of increasing it.”
“The cost of commodities is still well below where they could be, potentially, so it’s worth having some of that in your portfolio if you don’t already.”
Energy prices have been extremely volatile in 2021. In October, West Texas Intermediate crude was trading at multi-year highs of US$84 per barrel. While the price for the benchmark has come down, many analysts feel the current inflationary environment will lead to a prolonged period of elevated energy prices.
Sébastien McMahon, interim chief economist and portfolio manager at iA Financial Group, said he is also advising clients to load up on commodities and names in the energy sector, but is mindful of companies that don’t have the same pricing power.
“When you have higher energy prices, you can sell it at a higher margin,” said McMahon in an interview. “You can see underperformance in retailers who can’t compete on pricing against Amazon. Those may be areas you want to shy away from.”
“The big highlights that we found from looking at the past is that passive strategies don’t really work in an inflationary environment. So, in 60-40 passive investing, you tend to perform not too well when you have inflation in the economy and markets.”
A 60-40 portfolio is made up of 60 per cent equities and 40 per cent fixed income, but such a structure is bound to underperform amid inflationary concerns, said McMahon.
“We suggest everyone be a bit more active in their management,” he said. “Trend following strategies, in other words running after the assets that are outperforming and shying away or even short the assets that are hurt the most by inflation. This has proven to be a very efficient strategy in an inflationary environment.”
He also exercises caution investing in real estate stocks, specifically those with exposure to Canadian markets given elevated home prices and the increasing likeliness of a rate hike sometime in the middle quarters of 2022.
As a less traditional asset class, McMahon said collectibles like fine wine and baseball cards typically do well in an inflationary environment.
When it comes to what to avoid, Pelletier said he’s advising clients to consider “trimming back” on high-flying technology stocks and instead considering more “contrarian” segments of the market like growth as well as direct and indirect exposure to commodities.
NO CASH? NO PROBLEM
If there’s one thing all three portfolio managers agree on, it's that fixed income does not traditionally perform well when consumer prices are elevated.
“Fixed income doesn’t usually do very well when you have inflation and you have got rising rates,” said McMahon. “So it’s hard to recommend fixed income right now. Instead of having a typical 60-40, probably you need to have more equities and less fixed income.”
“Historically, cash was the thing to hold when there was inflation, because central banks were more reactive [but] we’re not living in that world anymore. Cash has not been a holder of value since 2008. You need to be more active in equities and look more at commodities.”
Pelletier is also not advising clients to increase their positions in cash, calling it a “precarious situation” given the level of debt countries have accrued through deficit spending.