Inflation is one of the most uncomfortable economic situations for most investors. Inflation implies to a decrease in purchasing power due to rising prices of goods and services, and impacts the real value of money. As Kavan Choksi Professional Investor says, this makes investing all the more challenging. After all, as per the traditional playbook of investing, one must invest in the market when prices are low and steer clear when it gets expensive. Such a strategy is hard to execute in an inflationary environment.
Kavan Choksi Professional Investorbriefly sheds light on how to manage an investment portfolio during inflation
Inflation makes markets volatile. In such situations, a large number of investors become wary and end up parking their investments in debt instruments like long-duration funds. Such funds basically invest in long-term-fixed-income securities that have an average maturity period of more than seven years. The exposure to long duration funds, however, can lead to losses. These funds are more susceptible to interest rate hikes. If one does want to invest in debt funds, opting for liquid and short-duration funds would be better. Liquid funds invest in securities maturing in 91 days. On the other hand, short-duration funds invest in money market securities maturing in one to three years. The maturity period of their core-underlying portfolio is low; as a result, they are prone to risks arising due to a hike in interest rates.
Investors must also keep guard against investments in fixed deposits. Even though fixed deposits do provide assured returns and tend to be latent to market volatility, their real returns might be in the negative territory. Real returns imply to the returns one manages to earn up and above inflation. For instance, if inflation stands at 7% and the fixed deposit returns are 6%, real returns are -1%.
As Kavan Choksi Professional Investor points out, companies that are under high debt often find it hard to get through high inflation. The situation tends to become worse for companies that are dealing with losses. A hike in interest rates results in higher cash outflow. Hence, investors should typically avoid investing in stocks of such companies. They need to go back to the basics and evaluate the financial of a company prior to investing in it. They need to check the balance sheet of companies prior to investing in them. If the debt amount in the balance sheet is too high, then it is better to stay away from the stocks of those companies.
Very often, the prices of thematic stocks go down during inflation. This may excite the investors and they can add those stocks to their portfolio in a hurry. But doing so can be costly. Thematic stocks that did well in the past may not be able to sustain themselves in the future. Hence, it makes little sense to invest in them. If one does want to invest in stocks during inflation, they must look for companies that have been able to retain the pricing power of their goods. A smart way to mitigate the inflation threat is to stick to the stocks belonging to large cap companies. These entities, being dominant figures in their respective sectors, possess a more robust structure to navigate economic challenges. While returns from large caps may not be exceptional, they offer essential stability and liquidity to the investment portfolio. On the other hand, mid- and small-cap stocks carry higher risks, yet they present the potential for superior returns compared to their larger counterparts. A careful evaluation of these factors is crucial for a well-balanced investment strategy.