Vijay Kumar Gaba

 One of the most common narratives in all the investment advisory pitches is the impact of inflation on investors’ wealth. Inflation is often termed as termite that silently destroys investors’ wealth. Protecting wealth from inflation is therefore one of the primary objectives of almost every investment strategy.

Over the weekend I examined more than twenty-five investment proposals, mostly focusing on elevated inflation and its impact on real returns. The common advice is to take higher risk by increasing the proportion of high yielding debt and equities.

Discussions with investment advisors indicate the investment strategies aimed at protecting the real (inflation adjusted) value of the investors’ portfolios may be based on poor, and often wrong, understanding of the impact of inflation on investors. Most of them presented the official data of inflation and suggested investment products that may yield a return that is higher than the official CPI (Consumer Price Index) inflation.

None of the 20 odd investment advisors I spoke with has considered that inflation is a very personal phenomenon. Every investor may have a different inflation number to deal with. The official CPI inflation may be of little relevance for a majority of household investors. The inflation affects rural and urban investors differently. The inflation also varies according to the State, an investor lives in and incurs most of the expenditure. The impact of inflation on investors’ wealth could be different depending on his consumption pattern and saving propensity.

·         The inflation rates for various states are different. In March 2023, West Bengal CPI inflation was just 4%, as compared to national average of well over 5% and Tamil Nadu inflation of 7%. Investment strategy for investors living in Kolkata and Chennai need to account for this difference.

·         The weightage of different states in calculation of CPI is also different. Maharashtra has a weightage of 13% (8% rural and 19% urban) in overall CPI basket; while Bihar has a weightage of 5%. Obviously, the investors in Patna and Mumbai face different inflationary impact; and their investment strategies to fight inflation need to be different.

·         The weightage of food and beverages in rural CPI basket is 54%, while in urban basket it is 36%. The combined basket has a weight of 46% for food. Obviously, food inflation impacts rural and urban investors differently. Rural basket has 3% weightage for Pan, tobacco and other intoxicants while urban basket has a weight of 1% for this. Similarly, the weightage of education, health and dairy consumption also varies sharply for rural and urban consumers.

·         The official CPI basket does not account for the inflation in housing and rental cost, which could be a significant expenditure for many investors, especially in urban areas.

·         One of the most important aspects of inflation consideration in investment strategy should be the saving propensity of the investor. An investor which is able to save 60-70% of his income cannot be put n the same bracket as an investor who saves just 10-20% of his income.

·         The investors who have significant debt and use most of their savings to repay the debt may have a self-neutralizing inflation. Similarly, an investor engaged in a money lending business might be much more severely impacted by inflation than investors who have significant borrowing.

·         A 70yr old investor with independent children, who consumes less cereals, education and transportation and more healthcare will have very different inflation impact as compared to a 40yr old investor with school going children and dependent aged parents will have remarkably different consumption basket and therefore inflation impact.

The point is that the impact of inflation is usually different for various investors depending on their individual circumstances and status. Therefore, investment strategy needs to be personalized for all investors, or at least class of investors. Selling the fear of inflation and making them invest in products which are benchmarked to official CPI may not serve much useful purpose for most of them.

Investors also need to understand their inflation profile and accordingly adjust their investment strategy.

         

 I have always believed that “equity investment” is a serious business but mostly done in a casual manner. In past three decades I have observed that most investors take equity investment decisions based on factors that are not related to the underlying business of the company they are investing in. While this may be more true for the small household investors (Retail) and High Networth Individuals (HNI); the professional fund managers (Institutions) and large traders are also seen taking decisions based purely on factors like politics, geopolitics, and monthly or weekly data (trade, jobs, production), etc. No wonder the “breaking news” on TV channels causes more volatility in stock prices than the management guidance about the business of the company.

I have seen many Retail and HNI investors spending less effort and time in taking equity investment decisions than they would normally spend on buying a shirt. And worst, they spend much less effort and time in taking a decision to dispose an investment than they would do for disposing an old shirt.

From the interviews and comments of some reputable professional fund managers it appears that they usually assign significantly higher weightage to the macro factors, especially political promise of policy reforms etc., than required, especially when the empirical evidence is materially against placing reliance on such political promises.

I am raising this issue this morning, because I believe that even in normal times, investors face numerous uncertainties and challenges. The consequences of these uncertainties vary vastly and are difficult to assess. Investors have to consistently struggle to assess the impact of fast changing technologies, markets, processes and methods on their investment portfolios. The consistently changing macro environment, e.g., interest rates, inflation, liquidity, demand etc., needs to be incorporated in assessing the sustainable valuations of their portfolio. The information asymmetry, regulatory changes, product innovation and debasement of governance standards at business entity level, are some of the regular challenges that an investor has to face. The challenges rise multifold in the uncertain times, like the present one.

The outbreak of pandemic has created enormous uncertainty in almost all spheres of life; especially businesses. A large number of businesses are struggling for survival. Multifaceted challenges have subjected a host of businesses (and some industries) with extreme uncertainties having material and severe consequences. Unlike the previous crises (dotcom bubble of 1999-2000 and global financial crisis of 2008-09), which mostly impacted one set of businesses, this crisis is more pervasive.

The impact of crisis led disruption is exacerbated by the fact that prior to the crisis the global economy was witnessing massive technology transition. Artificial Intelligence and clean fuel technologies were changing the landscape for many businesses. To make the matter more complex, the widespread trade war (involving USA, China, Japan, EU, and UK) was redefining the global trade and terms of trade. As per some reports, the IMF’s GDP contraction forecast for 2020 is more than double the estimated contraction that took place in 2009, the worst year of the global financial crisis.

The equity investors in India have made sub-optimal returns in past five years. Many investors are indicating that the past five year returns for them are in low single digits, with some reporting even negative return for past three years. In these circumstances, it is critical that investors make a holistic review of their investment process. Especially, those investors who have made material changes in their portfolio in view of the 2014 & 2019 India general elections and 2016 & 2020 US general elections, need to immediately sit with their respective advisers, if any, and make necessary amends.