A.T. Financial Newsletter
MUTUAL FUNDS
when converted back into local funds.

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
inflation hedge?
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.

Outpacing inflation
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
America from
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
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