Inflation affects the purchasing power of money. A portfolio typically constitutes of various asset classes. The way various asset classes counter/tackle inflation should be one of the indications on how much exposure you should take to that asset class.
In the long run, the asset class most likely positioned to beat inflation is equity. Good businesses that have the capability to generate healthy profit margins and cash flows come out stronger through challenges such as high inflation. They are able to reduce their leverage through cash accruals, borrow at competitive rates, negotiate better pricing from their vendors, manage their operating costs efficiently, pass on a part of the incremental costs to their customers due to their value-add and quality, take on a larger market share (from weaker competitors) to achieve higher revenue growth and continue to innovate and define new trends in their space. Of course, there are risks that these businesses face and not all strategies are necessarily good ones. So the only solution to that is to have enough of them in your portfolio.
The level of diversification though may depend upon several factors, including risk tolerance of the investor and time horizon, among others. What is most critical in equity investing though, is to invest in good companies and stay invested through the course until one finds a better company. Also, one should consider delegating the selection to experts, who have the time, experience and discipline to analyze these businesses and build relatively good quality portfolios.
If one does not have the appetite to ride through the equity market roller coaster, one may even consider incurring some costs (such as intermittent liquidity and/or some upside) to build protection on the way or at maturity through equity-linked structured products.
Large and sophisticated investors, with time on their side, may even consider allocating some portion of their portfolio to private equity in unlisted businesses.
Traditionally, for Indian investors, exposure to global equity markets has been restricted. However, now there are onshore products providing opportunities to participate freely in some of these markets. Also, there is a general apprehension that the developed equity markets over longer term do not tend to provide significant real returns over Indian inflation levels. However, if one incorporates the currency depreciation (partly due to high inflation levels), these investments may start making sense and provide additional diversification benefits (apart from giving access to great businesses globally).
Debt as an asset class would underperform in high/rising inflation scenario but that does not mean one should get out of the debt asset class during periods of high inflation. This could be a good time to lock in higher interest rates and ride through reinvestment risks during the low interest rate cycles. For investors willing to take higher portfolio risks, allocations can be made to actively-managed portfolios, where experts can build profit by trading in duration and/or credit spreads.
Commodities (except precious metals) may at best track inflation and tend to be very volatile. They are also cyclical in nature and do not lend themselves well to an investment portfolio. A more appropriate format to take tactical exposure to commodities could be through equity exposure in businesses or economies that benefit from higher commodity prices or through active managers in the space. Gold seems to have appreciated too much too fast and while it is generally perceived to be a safe haven, given the past history it can be volatile and has its own risk dynamics.
Real estate is an important asset class that has traditionally provided relatively decent real returns and we believe that it should form an important component of an investment portfolio. Diligence, demand and supply analyses in the micro market, liquidity and diversification are all important consideration while trying to build a long-term real estate portfolio.
Ultimately, a healthy mix of all of the above asset classes is needed to build a robust portfolio that provides optimal real returns in line with the investment objective of an investor over the long term.
Satya Bansal is CEO (India), Barclays Wealth and Investment Management.