The JMP Weekly Report with Chris Hagan

Protecting Your Portfolio Against Inflation

Chris Brycki

Keep it simple and focus on the total return, not just yield.

Key points

• Consider the impact of investment fees on long-term returns.
• Don’t chase dividend yield. Also, assess tax implications when selling.
• Understand the benefits and risks of inflation protection in portfolios.

Google has a nifty product called Google Trends. It’s a free service that analyses and charts the popularity of search queries entered in the Google search engine.

You can look at how often a term is being searched for and what country that query is coming from. One term I recently searched, using Google Trends, was the word “inflation”.

Looking at the results (search chart here), it’s clear that interest in “inflation” spiked in April 2022 and remains a popular search term. But what is inflation? And why does it matter?

The Reserve Bank of Australia (RBA) defines inflation as: “an increase in the level of prices of the goods and services that households typically buy.” 

Simply put, something that cost you $5 last year will, due to 8% per cent annual inflation for example, cost you $5.40 today. 

I am sure you are seeing some of this when you do your weekly grocery shopping. The rising cost of the products (i.e., inflation) that fill your shopping trolley means you have to pay more for what you usually consume. This leaves less money to be enjoyed on other things.

Uncontrolled, severe inflation can lead to social unrest and other problems, like having to use wheelbarrows as a wallet to cart your money around! (Google: “wheelbarrow inflation” to get a sense of how bad things can become!)

To counter this inflation, reserve banks usually lift interest rates to curb spending and reduce the amount of money sloshing around an economy. So, it’s not surprising that the term “inflation” spiked in Google Trends as the RBA first started raising interest rates back in April 2022.

If you earn 4% interest from your bank and the inflation rate is 7%, then the real rate of return on your money is -3%. That’s before factoring in taxes you might need to pay on the interest earned. This means that after tax you’re likely to have even less.

In a high inflation environment, you could potentially be going backwards by leaving most of your savings in cash and term deposits, as the prices of goods and services are rising faster than the prevailing interest rates.

Inflation, though, doesn’t have to be all doom and gloom. In fact, you can invest in a way that potentially helps you generate passive income and also protect your portfolio from inflation. 

To achieve this, here are three things that Stockspot suggests to its clients.

Tip 1: Stick with low costs and simplicity

[Editor’s note: Like all investment products, actively managed funds have pros and cons. The choice between active funds and passive funds (most ETFs) is not always binary. Different types of fund investment styles can play different roles in portfolios. Some active managers have delivered strong long-term returns for their clients, just as some managers have underperformed their benchmark index, after fees. The key is to choose the right investment style for your needs, on your own or in conjunction with a licensed financial adviser].

There’s a reason why less than 15% of active Australian share funds, according to the S&P Dow Jones research, have beaten the market over the last decade. It’s because the fees investors pay are a killer – much like termites eating away at your home, fees eat away at your money day after day.

While some active fund managers do have skill, the S&P research shows that over the long term, many active fund managers underperform the market.

Studies consistently show that low-cost index funds that track the broad market and passive ETFs tend to outperform their higher-cost, actively managed counterparts over the long-term.

This outperformance is largely due to lower fees, allowing more of your investment capital to work for you in the market. 

As an example, an investment product that charges you 0.3% compared to one charging you 1.3% means that on $100,000 invested over a 25-year period, a gross return of 8% ends up at $681,312 compared to $531,398. That’s a difference of $150,000.
 

Tip 2: Don’t chase high yields blindly

There’s a popular saying: if it’s too good to be true, it probably is. The same applies to the dividends (or yields) on shares.

As a kid, I remember visiting the ASX auditorium every Wednesday afternoon to learn more about investing. I would be mesmerised by the free educational talks offered and the bright ticker boards showing share price movements. I would then go home and research which companies on the ASX had the highest yields/dividends.

What I didn’t know at the time was that high-yield investments come with higher risk. Typically, investments offering high yields (say, of over 8%) can potentially be either risky or are complex structured products. 

With some funds, the dividend yield is a mirage – you are just robbing Peter (capital) to pay Paul (dividends).

Now, you may get lucky and get away with picking a high-dividend stock and being able to get your capital back. However, like picking up pennies in front of a steam roller, eventually the risk of this approach will be exposed because there’s no free lunch. Rather than focusing solely on income, consider the total return of an investment as your benchmark of performance.

Also keep in mind, if you’re investing in a taxable account (i.e. you’re not in the super pension stage), that higher-yield investments often face higher taxes because income can be taxed more heavily than long-term capital gains. 

Assess your tax situation and risk tolerance when planning your investment strategy. For many people, it may be more tax efficient to sell down some capital rather than get income. 
 

Tip 3: Include some inflation protection

As inflation and interest rates rise, high-dividend-paying shares and bonds with high yields can become relatively less attractive at the same time, potentially leading to price declines. 

To offset this risk, consider including inflation-protected assets in your portfolio like commodities, inflation-protected bonds and resource shares.

In a study by Cambridge Associates, commodity futures and gold topped the list of assets most sensitive to inflation. A 1% increase in the inflation rate over one year was estimated to increase gold performance by around 9.4%.

These assets were followed by resource shares and inflation-linked bonds. Assets that have historically done less well with rising inflation were traditional bonds and shares. 

The great thing is that these days all investors (from retail to sophisticated institutional players) can easily buy and sell gold, commodity futures, resource shares and inflation bonds on the ASX. Exchange traded funds (ETFs) have made this possible and lowered the previously steep barriers to entry for all investors.

By incorporating these assets into your portfolio, you can potentially reduce the negative impact of rising inflation and interest rates on your returns.

In my experience, the best way to keep up with inflation when investing is by keeping your portfolio costs low, diversifying broadly, owning some inflation-protected assets and focusing on total returns rather than dividend yields alone.

Risks with investing for inflation-protection

Be aware that some of these assets, like resources and shares, have a decent yield whereas others, like gold, don’t.

Generally, inflation assets don’t have high yields so this is the compromise you need to make to reduce the risk of having your portfolio gobbled up by rising inflation and interest rates.

 

ABOUT THE AUTHOR

Chris Brycki, Stockspot

Chris Brycki is founder and CEO of Stockspot, a leading automated online investment service.

Chris is presenting at the upcoming ASX Investor Day on this topic. To learn more, register for ASX Investor

Thank you ASX for this article from Chris Brycki, Stockspot

 

 

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Climate Risks To Financial Performance Are Hugely Under-estimated

 Mark Segal November 14, 2023 Guest Post By: Emma Cutler, Senior Analyst, Verdantix

News of climate change- and El Nino-driven drought slowing traffic in the Panama Canal hit headlines last week. Where the news will likely never appear, however, is firms’ own reporting, even for those that experience significant losses, at least not as a climate-related loss. Though the World Meteorological Organization cites economic damage from droughts as up more than 60% on its 20-year average, companies are today blind to the risk ahead from climate change and failing to account for the climate impacts behind them. For many, it’s simply because they don’t understand it.

Companies face a growing array of climate risks more immediate and severe than previously believed, from extreme weather events disrupting supply chains to rising climate litigation and regulations against carbon-intensive industries. Despite growing corporate concern about climate change, firms do not have access to the information and skills needed to understand and act on climate risk.

 

Firms underestimate climate risks

Climate change impacts are already noticeable throughout the global economy. Storms, heatwaves, wildfires, floods and droughts disrupt supply chains, affect labour and resource availability, damage infrastructure and increase operating costs. These acute hazards combined with chronic changes such as sea level rise are making some assets in high risk locations uninsurable. Research from Morningstar Sustainalytics found that with 2°C of warming, the average ratio of losses attributable to physical climate risk to operating cash flow could be nearly 4% for some industries.

Despite these material financial risks, Verdantix research found that 40% of corporate risk managers expect minimal or no risk to physical operations from climate change before 2030. The reasons for this disconnect come, at least partially, from a lack of information and skills. Climate expertise is concentrated in academic settings, rather than industry, and existing climate research, models and scenarios do not adequately capture risks to businesses. In a summer 2023 survey of corporate leaders, Verdantix found that lack of data availability is a significant obstacle to climate risk analysis and management for 36% of respondents, while approximately one quarter struggle to integrate insights into decision-making processes.

Many firms do not disclose financial impacts of climate change

Fewer than 30% of firms publicly disclose climate impacts on revenues, expenditures, assets, liabilities, capital and financing. Similarly, the Verdantix Climate Benchmark reveals that across 12 of the largest software companies in the world, disclosures regarding the impact of climate-related risks and opportunities, on average, address only 40% of TCFD recommendations. In the insurance industry, average disclosures of climate impacts meet only 30% of TCFD recommendations.

However, some firms do not have the luxury of ignoring credible climate risks, and – tellingly – these risks are moving much faster making it increasingly more challenging to understand, prepare for, and invest to manage them. Industries with direct exposure to climate change – such as utilities, energy and materials – are more likely to disclose financial impacts. Insurers and big banks, whose liability is distributed and societal, are more likely to be subject to regulation and may face even stricter requirements in the future.

Under-estimating climate risks creates new threats to business

Failing to disclose climate impacts exposes firms to litigation risks. Even in the absence of climate-specific regulation, corporates who do not disclose material impacts of climate change face allegations of securities fraud. These lawsuits have direct financial impacts and can harm reputation, creating a cascade of climate risks.

Mispricing presents an additional threat of under-estimating risk. When financial impacts of climate change are not accounted for, assets may be overvalued creating price bubbles. As climate impacts progress and extreme events become more frequent and intense, overpriced assets will be devalued with potentially devastating financial outcomes for public and private sector actors.

New approaches for corporate climate risk assessment are needed

Translating academic knowledge, data and climate scenarios to support industry-relevant research is critical. The IPCC emphasizes an optimistic future in which warming is limited to 1.5°C. However, businesses also need information about the economic impacts and adaptation options of worst-case outcomes including a 4°C scenario, which the French government included in its own analysis. To improve access to and the ability to use relevant climate data, companies should grow their in-house climate skills, while also engaging with climate change consultants, advisory services and digital solutions. Understanding the financial impacts of climate change is critical for corporate climate risk management and the future of health of businesses.

 

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Investors, Businesses to Increase ESG Investment Despite Greenwashing Scrutiny & Political Pushback: Bloomberg Survey

Mark Segal November 13, 2023

The vast majority of senior investors and business executives are planning to increase ESG investment over the next 5 years, with each group anticipating a range of benefits from a greater ESG focus, including 90% of investors expecting enhanced returns, and executives seeing improved access to capital and corporate reputation, according to a new survey released by Bloomberg Intelligence (BI).

For the report, BI’s inaugural ESG Market Navigator, Bloomberg surveyed 250 C-suite executives across a wide range of sectors, and 250 senior investors including asset managers, wealth managers and investment banks, across North America, Europe and Asia Pacific.

 

One of the report’s key findings was that the trend of increasing focus on ESG by both businesses and investors over the past few years appears to remain intact, despite various backlash headlines, with around three quarters of executives reporting that the benefits of ESG are worth the increased risk of greenwashing scrutiny, and more than half of investors saying that the political pushback on ESG in the U.S. has actually led them to focus on ESG more than ever before, and another 31% reporting that it has not affected their ESG strategy. A large majority of both groups, including 90% of investors and 67% of executives acknowledged that ESG has entered the mainstream.

The groups differed significantly in their rankings of long-term ESG benefits, with 63% of investors scoring   profit and returns as one of the 3 top benefits, the most cited of any factor, compared with only 32% of executives, who selected brand value most often, at 66%.

Among investors, 86% reported that they view ESG as part of their fiduciary duty, 90% said that ESG investments were expected to deliver better returns, while 92% said that ESG supports a more resilient portfolio strategy, and 89% reported that ESG analysis supports better informed decisions. Accordingly, most investors plan to grow their investments in the area, with 86% and 88% planning to expand AUM towards ESG and climate, respectively, over the next 2 years, and 25% reporting that they anticipate a greater than 30% allocation to ESG in 5 years, compared to 6% who expect this allocation in 1 year.

Similarly, 85% of investors report plans to boost their ESG research budgets over the next 2 years, including nearly one in four who plan to do so by more than 20%.

Investors also report becoming more active on engaging companies on ESG issues, with over 60% reporting that they challenge corporates on ESG strategy, and 84% saying that they see an increased focus on ESG on investor calls.

Executives similarly reported plans for near-term growth in ESG investment, with 77% anticipating an increased ESG budget in the next 2 years, including 23% expecting an increase of more than 20%. The surveyed executives cited a wide range of benefits to ESG, with 84% reporting that it helps shape a more robust corporate strategy, 81% saying they worry about losing market share if they fall behind on ESG, and 76% saying that an ESG strategy improves access to capital.

Additionally, 84% of executives reported incorporating ESG and climate factors in their corporate planning and M&A strategies, and while 57% said that they expect to hit their net zero targets, only 33% expect their peers to do so.

One of the top key trends cited by both groups for the next year is the impact of AI on ESG, particularly as a source of addressing data problems that have been a barrier to investor and corporate ESG initiatives. More than 90% of executives and investors agreed that “AI is a friend of ESG,” with top cited benefits including better data estimation, improved supply chain traceability, and the ability to track controversies.

Adeline Diab, Global ESG Research and Strategy Director at Bloomberg Intelligence, said:

“ESG has moved from a fringe concern, to mainstream and finally, to a mandated necessity. We expect 2024 to be about ESG accountability and an era where investor-corporate dialogue will be vital, 60% of investors hold companies answerable on ESG, while 40% of executives face ESG questions on over half their investor calls. I firmly believe that scrutiny will help shape a more credible ESG market overtime.”

 

 

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Guide How to Uncover Hidden ESG Risks in Your Supply Chain

Introduction Supply chains were never built with sustainability in mind, which means manufacturers with complex supply chains face unique challenges when it comes to environmental, social, and governance (ESG) management. For most manufacturing verticals, the supply chain contains the majority of ESG impacts.

 

That’s why you need to collect ESG data from — and about — your suppliers to create meaningful insights about your total risk and performance.

 

One of the biggest challenges manufacturers face when it comes to ESG is that they don’t have the deep visibility into their supply chain that is required to capture hidden risks or the ability to translate that information into actionable ESG business intelligence.

 

Most ESG solutions deliver minimal, shallow information, and are not designed for the specific needs of manufacturers. This guide gives you best practices to improve your ESG risk management and protect your business from the biggest threats to your sustainability.

 

You’ll learn: X Which hidden risks to prioritize X A method for proactively uncovering and mitigating those risks X What a strong ESG risk monitoring program looks like. How to Uncover Hidden ESG Risks in Your Supply Chain

 

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