The Malta Independent 5 March 2024, Tuesday
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How to Safeguard Your Investment Portfolio from Inflation & Global Economic Uncertainty

Thursday, 9 February 2023, 13:41 Last update: about 2 years ago

The Russia-Ukraine conflict has disrupted supply chains globally, and fractured relationships between nations. This has led to record high inflation even in the most viable economies.

The EU has an inflation figure of 9.2% as at December 2022 & 7.2% in Malta. The European Central Bank (ECB) has also hiked interest rates from negative, to zero, and now to 2.5%, to cool off demand & reduce inflation.

The ideal inflation rate for an economy is said to be less than 2%, and when it is higher than this, it can be counterproductive as it depreciates the value of money, can affect the currency and scare Foreign Portfolio Investment (FPI) away.  

There is only so much that the ECB can do because excessively hiking interest rates has the risk that ir can run the economy into a recession.

These are uncertain times for investors, but there are some measures which retail investors can use to hedge against inflation by diversifying across asset classes. 

Park Your Money in Bonds

Bonds have been the worst performing asset class in 2022, with many Bond investors facing record losses. Many bonds were trading at very high prices (many yielding negative interest rates in EU), but the high inflation forced many Central Banks to hike quickly.

For example, the 2 Year German Bonds now yield around 2.5% & 3-month is at around 2.3%, as per the latest rates in Feb 2023. This Real yield is still negative when adjusted for inflation, but still, you now have an alternative of just holding Cash & earning Risk Free.

Although there is risk that the yields could go even higher, but if you are willing to hold till maturity there you can earn this Risk-free return in your portfolio without exposing yourself to the risk of uncertainty in Risky assets. 

Consider Investing in Real Estate

While rising inflation and can hurt your investment portfolio, real estate can help hedge against the effects of inflation.

Real estate is desirable because landlords can easily increase rent as inflation increases. Occupants of rented properties have no option than to pay, since buying houses is a more expensive option, with hiked interest rates affecting monthly mortgage payments negatively.

You do not have to buy a property before you invest in real estate. You can diversify your portfolio and consider some publicly traded Real Estate Investment Trusts (REITs). They manage various types of properties for commercial purposes, and are mandated to pay 90% of their taxable income as dividends to their unit holders.

An investment in REITs will let you earn income from real estate, without the challenges of owning or managing any property.

However, some REIT companies usually find it hard to expand when central banks hike interest rates to fight inflation. This is because REITs depend on loans to build houses, so repayment can be a challenge.

In periods of high inflation, REITs holding hotel properties may see a drop in profitability as people cut back on lavish spending. However, REITs that operate apartment properties or commercial assets with strong income streams, could be good addition to your portfolio as people need a place to live & businesses still operate.

Experts advise you need to understand the kind of property the REIT owns whether residential, or commercial etc. You also need to know where these properties are located, to avoid country risk due to political events like wars. 

Exchange Weaker Currency for a Stronger One

Amid the rise in inflation, Central Banks often increase interest rates to tame the rising inflation. This most time puts strong currencies in a stronger position against weaker ones. Strong currencies such as US Dollars, and Swiss Franc; often rise against weaker currencies, thereby giving them more purchasing power.

You can exchange weaker currencies for strong ones in either the spot or online forex market. The spot market is where you trade currency for "on-the-spot" delivery. In order words, you are swapping one currency for another, at the prevailing exchange rate at the time.

In the online forex market, exchange of currencies for speculation is done by trading a CFD contract at regulated online forex broker that is licensed to accept clients in the EU. These are derivative contracts such as Contracts For difference (CFDs), which let you bet on price movement of a currency pair without owning them.

It is important to note that though enticing to many, CFDs carry an inherent risk because they are leveraged products, meaning you use borrowed money from your broker, in addition to your own money. This leverage you take attracts nightly interest payments for as long as your position is open.

Leverage also poses its own risk, as it could net you more gains, but could also net you huge losses if the market moves against you. While there are ESMA restrictions on leverage allowable in Europe where leverage is pegged at 1:30 max, brokers from Asia, and other offshore regulations still allow leverage to the tune of 1:1000.

For a 1:1000 leverage, you only need to provide 1/1000th of the contract sum while your broker borrows you the balance. You become highly indebted and face a higher risk of being stopped out of the market.

For a leverage of 1:30 you put up 1/30th of the contract sum as margin, while your broker borrows you the balance. Leverage should be used sparingly when trading currencies. 

Consider Buying Military/Defense Stock

Defense stocks have strong fundamentals today because of heightened government spending on defense around the world.

Defense stock could make a good addition to your investment portfolio. In the wake of the Russia - Ukraine crisis, the shares of several US-based military companies including Lockheed Martin saw a double-digit gain.

A consulting firm, Bain & Co projects that European nations may spend an additional $75 billion on military and defense, in response to Russia - Ukraine crisis.

The US national defense budget estimate for FY 2023 also estimates US defense spending increasing from $756.6 billion in 2022, to $773 billion in 2023, and expected $801 billion in 2024.

The inflow of capital into military and defense companies will always add a fundamental strength to their stock, & therefore an attraction to investors.

Even when the Russian - Ukraine crisis is over, countries across the world will likely continue to increase their defense budget, to be prepared for uncertainties. 

Consider Adding Value Stock over speculative Stocks to Your Portfolio

Value stock trade at a price that doesn’t reflect their good fundamental performance. It is when all or most of the available data, shows that the price of a stock, should be higher than what it currently is trading for.

Don’t confuse value with penny stock. Penny stock many times have poor performance fundamentals, but value stock have good fundamentals but a low price.

Because of their large market capitalization and strong fundamentals, most value stock pay dividends to shareholders. In fact, value stocks sometimes outperform the overall market during high inflation.

This can be helpful to protect your investment during such a period. Additionally, value stock also pays dividends to shareholders which can help to increase your purchasing power during inflation.

Value stock can be identified by their low PE ratio, as their stock are not overly subscribed. This is in contrast to growth stock that have high PE ratios.

Many old established companies like energy companies have value stock. Companies in the energy sector generally do well during high inflation. 

Gold can offer Diversification

Gold has proven over time to be a safe haven against monetary policies. Since gold offers stability and is perceived as a store of value for the long term, a portfolio diversification of certain percentage of your portfolio into gold can give you a hedge against inflation.

You do not need to buy physical gold before you can invest in gold. You can purchase miners' stock or better still, buy shares of gold Exchange Traded Funds (ETFs). This will save you time and trouble of sorting the right gold stock to buy.

However, whenever the US dollar is strong, investors turn their backs on gold, and move funds to the US. In such a scenario gold prices may fall, but when the dollar is under pressure, investors run back to gold. 

Uncertain Environment

The currency global environment is highly uncertain. So, retail investors should look to protect their wealth & not take unnecessary risks. Diversifying across asset classes can offer hedge against uncertain events, but you should avoid gambling your money on meme stocks, or leveraged bets.

There are different ETFs that can spread your risk amongst different stocks, so you would only lose in the event that all the companies underperform at once. There are Gold ETFs. Bond ETFs, etc. so you can diversify across all different assets.

Above all, you must take all the necessary measures & avoid excessive risk taking, and be patient.


Content supplied by Karan Singh
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