Should investors position themselves for inflation?

Written by Tan Su-Yin
Tuesday, 08 September 2009 14:05

KUALA LUMPUR: Globally, inflation has been very tame in the midst of the financial crisis, with some deflation being recorded. But the threat of inflation looms as the economy begins to recover, although
the strength of the recovery is still in dispute. The trillions of dollars pumped into the financial system is also speculated to cause an outbreak of inflation.

Should investors be concerned about inflation and position themselves accordingly? "Our view is that inflation will rise but given the balance sheet destruction that has taken place the past 12-18 months particularly in the Western world, end demand is unlikely to rebound significantly," says HwangDBS Investment Management Bhd chief investment officer David Ng. "Moreover, there is still significant slack persisting in most economies. As such, core inflation, while headed higher, should not rise too fast. This is corroborated by the bond markets where yields remain low suggesting that the pace of economic recovery will be muted."

UOB-OSK Asset Management Sdn Bhd CEO Lim Suet Ling says that they are not particularly concerned about the resurgence in inflation in the immediate term (at least for the next 6-12 months). "Economic and financial conditions might have improved but going forward the recovery is likely to be sub-par.
Consumer spending in US remained weak amid uncertain job prospects, decelerating wages and incomes, reduced wealth, high debt burden and tight credit conditions." However, she adds that as growth momentum picks up over the longer term, there will be inflationary pressure.

Domestically, fund managers expect inflation to trend higher in 2010 due to higher energy and transportation costs and the knock-on effects."Another possibility for Malaysia is the introduction of goods & services tax (GST) which tends to lead to higher prices for goods and services," says Ng. Lim expects 2009 consumer price index (CPI) to come in at around 1% and trending higher in 2010 to around 2%

While the managers do not expect runaway inflation, they advise investors to have exposure to asset classes that would do well in an environment of rising inflation (such as commodities and property) as inflation will pick up in the longer run. Lim says that such assets also have low correlation with other asset classes and will offer diversification for the investors.

Ng says HwangDBS is positioning towards a recovery of the global economy in the near term, and some return of inflation is to be expected. "Our funds are exposed to sectors that tend to do well in such a scenario such as banks, property and commodities." The HwangDBS Commodity Fund's largest exposures are to the energy and agricultural sectors, expected to be beneficiaries of a recovering economy
and rising inflation expectations.

Lim says that as a hedge against inflation, they would look to invest in commodity-related stocks.
"For Malaysia-centric funds, the main exposure is through the plantation and oil and gas sectors. For regional mandates, we would also look for companies in food produce, base metals, coal and gold sectors."

Gold, usually viewed as the traditional hedge against inflation, has held steady this year and prices rallied last week (almost breaching the US$1,000 per ounce mark) amid fears of the stock market faltering, and of inflation due to government spending. "In the short term, gold prices will no doubt be subjected to volatility. However, over the long term, gold has always managed to maintain its purchasing power," says Ng. "Spot gold did not lose its appeal during these times as it held up relatively well. For investors who want to hedge against potential inflation, buying gold could be a good diversification plan in 2009/ 2010."