when converted back into
Equity mutual funds offer signicant
advantages over bond funds in an inflationary
environment, because the earnings of the
companies that they invest in will rise in such
an environment; however, the interest that
previously issued bonds pay will not.
Inflation risk may be rising
In late 2013, the urgency of considering
possible inflation hedges increased, with the
announcement that Janet Yellen will be taking
over as the U.S. Federal Reserve chairman in
early 2014. She is thought to place priority on
job creation over keeping inflation low, which
could significantly heighted inflation risks. 2
As if that were not enough, inflation
pressures from China are showing signs of
spreading into western economies. Low
Chinese wages have long been a key factor in
keeping prices low for many of the goods
that Canadians import, ranging from textiles,
to toys and iPhones. However, Chinese
wages have been rising 3
and the effects risk
spilling over into Canada.
In short, savers need to think ahead.
While phrases such as "the risk of inflation,"
may seem tame, they need to be taken
seriously. Talk to us about how to position
your mutual fund portfolio to hedge against
possible inflation down the road.
1 Jeremy Siegel, "Stocks: The best Inflation Hedge," Kiplinger.
com, June 9, 2011
2 "Janet Yellen will stick to her predecessor's expansionary
policies," The Economist, Oct. 12, 2013
3 "Manpower CEO Joerres Says Wage Inflation May Aid China
Economy," Bloomberg News, Sept. 12, 2013
Are equity funds a good
The U.S. Federal Reserve has been following
an ultra-low interest rate policy since the
2008 financial crisis. Many fear that the resulting
cheap credit could lead to rising prices
down the road - in other words, inflation.
Warning younger Canadian savers about
inflation these days is hard, because few
have witnessed its pernicious effects as price
increases dilute hard-earned buying power.
The effects can be signicant, especially
for seniors living on fixed incomes. For
example inflation of just 3% a year would
cut the purchasing power of a senior's
annuity payments by close to half (46%)
over two decades.
Historically, gold has long been considered an
effective inflation hedge. However equity
mutual funds may fill a similar role.
Jeremy Siegel, a professor at the Wharton
School and author of Stocks for the Long Run
notes that the businesses that mutual funds
invest in are "claims on real assets, such as
land and plant and equipment, which
appreciate in value as overall prices increase." 1
Although there can be signicant shortterm
fluctuations, Siegel says over 30-year
periods "the return on stocks after inflation is
virtually unaected by the inflation rate." 1
Picking individual equity winners in the
inflation hedging game is hard, because price
increases can be volatile; some industries are more
vulnerable than others. Statistics Canada even keeps two measures of inflation to account for this disparity. The Consumer Price Index (CPI) targets a broad basket of goods, but the core CPI excludes food and energy prices, which tend to be more variable.
How mutual funds can help
The upshot is that investors who want an
effective inflation hedge may be better off
investing in a professionally managed mutual
fund, rather than trying to figure out which
individual companies will outperform.
One especially effective option is to invest
in an international mutual fund that has
heavy allocations in countries with a history
of stable money. That way, if inflation rises in
Canada, you stand to be compensated, as this
would cause the Canadian dollar to fall and
your foreign-currency fund units would then be worth more
Could inflation spread here?
In a global economy,
there is a danger
that inflation could
spread to North
countries where it is
higher. This chart
provides a snapshot
of current inflation rates
around the world.*
* Monthly inflation, Nov. 1, 2013. Source: WallStreetDaily.com, trading economics