How can you inflation-proof clients' portfolios?

Choose monopolies and diversify within different sectors, countries and asset allocations, says portfolio manager

How can you inflation-proof clients' portfolios?

With inflation having climbed to an 18-year high and now looking like it is here to stay for a while, BMO has some suggestions for how portfolio managers can protect their clients' assets.

“We’ve had a very good run in the market,” Melanie Segal, a portfolio manager and Senior Vice-President at BMO Nesbitt Burns told Wealth Professional. “But you have to stick with really good quality right now and make sure you’re upgrading your portfolio.”

Statistics Canada just reported that inflation has risen above the Bank of Canada’s 3% upper threshold for seven straight months, clocking in at 4.7% in October after exceeding 4.4% in September. It has reached its highest rate since February 2003. That’s beginning to challenge the Bank of Canada’s recent assertion that it’s a transitory phenomenon, and Segal said it is “just getting to be a bit of a concern right now".

While Segal noted that we’ve had very low inflation for decades and technology has helped to reduce costs, food, gas, and other prices, such as for appliances, are increasing. The question now is how much is tied to the pandemic and may recede, how much reflects changing patterns and habits, and what impact sticky wage inflation may have on it. Many industries increased their wages to attract, or hold, workers during the pandemic, and now there is some question as to whether those will fall again, especially if a fourth pandemic could impact everything, including rates.

“This is a once in a 100-year event. So, there might be a huge demand in the short-term, but then things might taper off,” said Segal. “But, with huge demand, people are going to pay more for goods, like used cars. I think everyone is trying to figure this out, but we won’t know until we get through this.”

Segal suggested that when portfolio managers review their portfolios, they should look at high-quality companies that are oligopolies or have monopolies – such as waste disposal and railroads – but also diversify within different sectors, countries, and asset allocations. She said equities generally perform better than fixed income if there is some inflation, but there are many sub-classes of fixed income, with outstanding technology companies still a good pick. Clients should also have cash in an emergency fund.

She’s still adding a lot of alternatives to her book - but said “gold is tricky” - and real estate is an important part of a portfolio as it offers a bit of an inflation hedge.

Noting interest rates may also be impacted, Segal suggested those who have variable rates on debts, such mas mortgages, should lock in before the rates increase as the dollar-spread could make it harder for them to meet expenses. Clients should also be careful about increasing their debt and pay it down instead.

BMO Economics Special Report, Livin’ on the Hedge: Inflation and Your Finances, also released following Statistics Canada’s report, noted that when diversifying geography, it’s important to note that inflation isn’t heating up everywhere. Japan’s consumer price index rate, for instance, was almost zero in September.

Overall, though, Segal said while there are questions about whether managers should retain the classic 60/40 portfolio balance, “people should stick to their plan and look at the long-term to make sure they’re set up for their long-term goals.

“One has to really make sure that your portfolio is invested in top-quality companies because, if you don’t and the rates do go up a lot, then the companies that are more leveraged or have been stretched will have a tougher time thriving in this environment. You might then see more mergers and takeovers."