Investment in an inflationary environment

Investing in an inflationary environment is new to me in practical, but not theoretical, terms. It has been obvious for over a year now that this current inflation was emerging. But it hasn’t made the practical decisions of how to invest any easier. The last time the world’s major economies experienced significant inflation was at the end of the 1980s. I didn’t have any money to invest back then, so my understanding was theoretical, not practical. I read about it. Fast forward 30 years, I’m now living on the success or otherwise of my investment decisions in what is turning out to be an inflationary environment. At the beginning of 2021, I made my views clear in public professional circles that inflation was emerging as a looming threat. Many didn’t believe me. But we all have to deal with it now.

So, how to invest?

The sharemarket is at an all time high. Interest rates have been held artificially low for over a decade. Rates are rising, so asset values will fall. What’s a retiree to do? Or, for that matter, a fiduciary trustee? It has been occupying my mind. In part, I have been personally defensively positioned portfolio wise due to the excessive stock market valuations. But, there is nothing to be made in bonds or interest rate securities. Now that the real value of currency is depreciating, action is needed because assets denominated in monetary terms will lose purchasing power. So here is what I have been doing. I mention this as illustrative, not advisory. I am not responsible for any losses you may incur by following my actions as if they were advice.

I went looking for publicly listed equities with certain characteristics. Strong balance sheet. Low long term debt. Capital structure biased to shareholder equity. Established cash flows from a diverse customer base. Consistent conversion of cash flow to earnings. Proven efficient use of capital. High level of payout of earnings in dividends. Competitive advantage. Barriers to competition. A product that is not sexy or subject to oohs and aahs from wet graduates in the analyst team. Producer goods, not retail goods. Low intangible assets. Geographically diverse supply chains. Diverse shareholder register. Commodities fundamental to life. Stay away from tech. An acceptable price on the market. Not that hard, really.

I use my stockbroking platform to apply search filters to sort out potential assets depending on valuation criteria that I specify. For those that catch my attention, I go to their website to get into the investor relations section, download annual reporting material and begin reading and further filtering. It is time consuming hard work, although it can be fun. For example, I like to reward myself with a Tim Tam (chocolate biscuit for non-Aussie readers) if I find an annual report in which the Chairman’s address to shareholders does NOT contain the statement “the Company has a strong balance sheet that positions us well for future growth.” In the ESG and Climate Change sections, the reports are all virtually identical. Every Company is proud of its commitment to a decarbonized economy. Don’t forget diversity, inclusion and equity. I have a theory that all CEOs chat to each other and share the accepted paragraphs for the coming year annual reporting season on DIE and Climate Change reporting. It’s fluff and irrelevant. Ignore it.

Anyway, back to the point at issue. I have been anxious to reduce assets held in monetary denominations (bonds and cash) in favour of assets in economic worth, that is to say, equities: a share in future profits rather than a monetary amount. In an inflationary environment, this becomes more important than ever.

Well, I have found some. I have been researching for several weeks and today took down some cash and added five equities on the ASX to my portfolio. They are biased towards mining and metals, with a bit of property and agriculture. I’m still holding some cash as I want more agriculture in the mix. Overall, I switched around 10% of asset allocation from cash to equities today.

Now is the time for cash cows with pricing power, low debt, producing fundamentals.