December 16, 2009

The inflation risk

I think the inflation risk is now obvious to most of us, even if we don’t read the papers everyday. Even if the government claims the inflation is 4% or so, buying a kg of potato or sugar gives a different view of reality. So what do we do in response or if we need to do anything at all.

As far as equities are concerned, I rarely do any top down analysis and so I frankly don’t have any specific plans for my current holdings based on the inflation risk. No logic of inflation resulting in an increase in interest rates, in turn driving down demand for cars and hence the sales of an auto company.

I personally plan to avoid investing in long term deposits or long dated debt funds. If the inflation risk persists and the RBI decides to raise the rates (I have no idea if it will or not), then buying long duration debt fund or a long term deposit (more than 1 yr) would lock you into lower interest rates.

I plan to put my surplus cash in short duration floating rate mutual funds such HDFC floater and others. I don’t have preference for any specific ones, as most are identical and there is not much difference between them. If the rates do rise, then these funds should cover the inflation risk on the cash.

13 comments:

KD said...

Hi Rohit. Good Morning. Looking at quick rise in inflation, interest rate increase seems unavoidable. I agree on your comment on ST / floating rate funds. Based on some research done sometime back, I could figure out following based on returns, holding and expense ratios: LIC Float (Short term) and HDFC High Interest.

karthik said...

Hi Rohit,

I was trying to look up some floater funds in Value research after your article. Found a few like HDFC Liquid Premium or premium plus.

1.Are these the floater funds you are refereing to ?If not can you give a name of a specific fund(as an example)
2. What are the advantages of these floater funds to a bank FD?
3. Are these taxable and at what rates?

Gautam said...

Hey Rohit,

You're right about the inflation risk. It will affect interest rate sensitive sectors like Auto, FMCG, Real estate... And it will be advisable to invest in a company which has got some pricing power.

For more on inflation and RBI’s rate action read my latest post here -
http://economy-watch-gautam.blogspot.com/2009/12/food-prices-on-fire-i-see-some-actions.html

Rohit Chauhan said...

Hi KD
i have not looked at HDFC high interest, but LIC floater looks similar to other floating rate funds. overall other than cost, i have not seen too much difference between funds. would prefer to pick funds with lowest cost

rgds
rohit

Rohit Chauhan said...

hi karthik
I have written about floating rate funds here - http://valueinvestorindia.blogspot.com/2008/07/assured-way-to-lose-money.html

hdfc liquid premium is not a floating rate fund ..its a short duration fund. it may still lose value as interest rates rise, but lesser than long duration ones. for floating rate fund try to look for the term 'floating' in the title.

advantage of floaters over FD is the liquidity and that their retruns are variable with changes in overall interest rates. in FD you are tied to a specific rate and would lose some amount if you break the deposit.

disadvantage of floaters is the cost and management fees

their taxation is similar to any other mutual fund or FD

rgds
rohit

Rohit Chauhan said...

Hi gautam
you are right on investing in companies with pricing power. but that conclusion is irrespective of whether we have inflation risk or note. companies with competitive advantage have pricing power and can raise prices if there is inflation or maintain it even when there is competition.
As a result, i have found that it more fruitful to do a bottoms up analysis of a company with competitive advantage and invest a good prices than worry about macro factors
rgds
rohit

Vic said...

Hi Rohit,

I have heard Real Estate is a good hedge against inflation.

Do you agree? I know you don't consider RE as an investment, more for personal use.

Thanks,

Vikas

Vic said...

Hello Kd, Karthik and Rohit,

The Floater funds, are these bought/sold same as any other Equity MF?

Can you please list some top choices (exact names) and mention the cost (ER, management fee or any Load)?

Thanks,

Vikas

karthik said...

Hi Rohit,

I was trying to buy a floater fund today for Rs 10000 using ICICI direct (BIRLA FLOATING RATE - SHORT TERM PLAN - PLAN B GROWTH). But I realized that ICICI direct is charging 110 Rs as transaction and service charge. This is 1% of the amount I was planning to invest. Is this normal? or is Floter funds best used for Larger amounts? Will there be a transaction fee when I sell also?

Rohit Chauhan said...

Hi vic
yes, RE is a good hedge against inflation, with a cavaet that it is bought at reasonable price and not overvalued.
problem is Re is like any other investment, but somehow people dont look at it in that way
rgds
rohit

Rohit Chauhan said...

Hi karthik
i could see any transaction fee for my purchase of HDFC floater.

if there is a 1% charge, then there is no point of buying the floater ..too expensive ..far better then to just buy a deposit or invest directly through the mutual fund company

Rit said...

I think one way of tackling inflation is not to hold much cash (or equivalent) except for a contingency fund. Last one year has demonstrated this well. Even gold which is a traditional hedge or a preserver of value has given better returns than so called investment classes. Though there is no proper way of investing in sugar, tea, potatoes & food commodities for long term (other than stocks of commodity companies), it may be worthwhile to be invested in different asset classes. I believe, going forward, trend may be no different when investment in pure cash or debt instruments will underperform others. Pardon me if this view is contra.

Rohit Chauhan said...

Hi RIT
why do you say gold has given better returns than investment classes. if i am not mistaken gold has given 32% return compared to 50%+ returns for equity.
i agree on your second point - diverisfication will help and in short run debt may underperform inflation too.
cash as a matter of fact always underperforms inflation
rgds
rohit