On the up: what would inflation mean for investors?

Ninety One’s portfolio managers consider the investment implications of a more inflationary environment across equities, fixed income, commodities and multi-asset portfolios.

Dec 14, 2020

8 minutes

Ninety One’s portfolio managers consider the investment implications of a more inflationary environment across equities, fixed income, commodities and multi-asset portfolios.
Quality companies retain advantages through the cycle

Clyde Roussouw, Co-Head of Quality

Quality companies would benefit from pricing power
Pricing power, derived from enduring competitive advantages, should benefit quality companies in an inflationary environment and help mitigate any negative effect resulting from the long-duration nature of their cash flows (to the extent that inflation leads to rising interest-rate expectations and therefore higher discount rates that reduce the net present value of those longer-dated cash flows).

Capital-light models are an advantage in inflationary times
Quality companies also benefit from capital-light business models. The nominal value of their intangible assets should rise with inflation, and they should be less impacted by inflation’s effects on required capital expenditure, given their low capital intensity.

Take a long term view, but stay diversified
The reflation trade typically favours shorter-duration value and cyclical stocks. This trade can be short-lived, however, particularly if driven more by sentiment than fundamentals (as has been the case historically), and not supported by long-term sustainable growth.

Our Quality portfolios are well-diversified by sector and geography, and well balanced to include exposure to select quality cyclical companies as well as more defensive businesses and structural-growth compounders (such as high-quality capital-light financials like savings platforms and wealth managers). In addition to valuation discipline (‘quality at a reasonable price’), this helps to mitigate the impact of any rotation in the short term. We still expect quality to outperform over the longer term. Importantly, we think the market has already priced in a lot in terms of reflation/economic recovery and rotation towards value/cyclical stocks.

Caution on the inflation outlook
As bottom-up long-term stock pickers, we do not attempt to make top-down macro/market forecasts. The latter is prone to error, particularly given current uncertainty, and we do not have an edge here.

We do, however, observe a number of reasons why inflation may not in fact take hold in a sustained and meaningful way. A non-exhaustive list includes: spare capacity post-COVID and an uncertain recovery; debt overhang (across governments, corporates and households); continued technological disruption; continued growth of e-commerce and discounters (further enabling price awareness and price competition); and demographics (ageing populations with higher levels of savings to protect).

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