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Investing to beat inflation

INVESTING with a view to beating inflation sounds like an almost common sense objective, but it is by no means simple. In the last decade or so, it had seemed as if inflation had been tamed; indeed, disinflation was the order of the day. Now with rising oil, food, resource and asset prices, concern over inflation has resurfaced.

For Singaporeans used to sitting on cash, this poses a significant challenge. In the past, risk aversion and the preference for ‘safe’ investments may not have hurt as much as assets in fixed income instruments still earned a positive – if modest – real rate of return. But today, based on recent inflation statistics as well as official projections for 2008, that no longer holds true.

As at October, Singapore experienced an inflation rate of 3.6 per cent, against the three month interbank rate of 2.6 per cent, a negative gap of one percentage point. The official projection by the Monetary Authority of Singapore is for inflation to rise to 3.5 to 4.5 per cent next year. Whether this will become a long-term trend is debatable, but in the short to medium term, upticks in inflation are not an unreasonable expectation, given the demand and supply imbalance in the resource markets.

Professionals who advise individuals on their investments should drive home the relative merits of saving versus investing. The former simply keeps money in a low-risk instrument, be it a deposit or money market fund. The latter takes on an element of risk in the hope of a long-term gain. The long history of returns is not reassuring in terms of both inflation and cash. Between 1900 and 2006, as academics at the London Business School have chronicled, inflation was a major force globally. In the UK, inflation averaged 4 per cent and in the US, 3 per cent. Over the period, US and UK investors earned annualised real returns of just one per cent in Treasury bills, the equivalent of cash. And there were negative real returns in five countries. Returns from bonds were not reassuring either. The annualised real return on government bonds across all countries was just one per cent. What is clear from the recent history of Singaporeans’ investment habits is their preference for capital preservation, and for investments to be neatly packaged into an insurance bundle of an investment fund with life protection or a traditional life product with smoothed returns.

More recently, the preference has also been for a plethora of structured products. The big gap in the marketplace, however, has been in inflation protected instruments, whether a fund, a bond or insurancelinked product with inflation indexation. These surely are not difficult for product providers to structure.

The products need not be capital protected, but they should have an inflation-plus return objective. This suggests an absolute return orientation.

Meanwhile, the risk of staying in cash is serious. Just as the magic of compounding can work over time to build a nest egg into a tidy sum, it can work in reverse during inflationary periods to erode the value of savings.

 

Source: Business Times 7 Dec 07

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