Despite the fact that the most repeated message in the market is that the rise in inflation is transitory, there are many data that suggest that the recent increase in prices could be with us for longer than expected. The investor has lived in recent years in a scenario with hardly any inflation and with interest rates at zero (negative rates if we look at the 12-month Euribor), and it seems that this scenario is changing.
The euro zone inflation it has risen to levels not seen for 13 years, reaching 5.4% in Spain, for example, and in the US it has risen to 6.2% in October. Looking at the long-term outlook for the markets, inflation is expected to remain above the 2% target set by the ECB. These levels cause erosion of profitabilityespecially for the more conservative investor, favoring debt issuers instead.
That is why, from the Welzia Management management team, we look for assets and sectors that offer our clients a greater resistance to future rises in inflation or persistence over time. A good example of this is the energy and financial sectors, both of which have traditionally performed well in environments of rising inflation such as the one we are currently experiencing.
The energy sector, which includes companies from oil and gas, is one of the most resistant to inflation, which is logical since the income of energy companies is linked to energy prices, a key component of price indices (CPI). By definition, when inflation rises, energy companies do better.
When inflation rises, energy companies perform better
On the other hand, the companies financial sector they tend to behave positively in scenarios of controlled inflation increases, since their cash flows are concentrated in short-term periods. However, long-term persistent high inflation can be harmful, if not accompanied by proportional increases in interest rates, because it dilutes the current value of existing loans that will be repaid in the future.
Another example of companies that resist inflationary rises are real estate since they have the facility to transfer that price increase in their rental contracts or sale prices of their properties.
Lastly, the raw Materials they are one of the assets that performs best in inflationary periods, in fact, the rise in the prices of raw materials (steel, nickel, aluminium…) is one of the factors that has caused the rise in price indices.
Within raw materials, gold should be highlighted, as it is one of the assets that usually reacts positively in scenarios of high inflation, although the historical results of precious metals companies or the mining sector do not show constant results in this kind of situations. An example of a mining company is Río Tinto, which in addition to extracting gold, exploits other raw materials such as coal, iron, aluminum, copper… We have taken advantage of the recent falls in the price of iron to incorporate it into our portfolios.
In line with what has been said, throughout 2021, both in the investment funds and in the positions of Welzia Management clients, we have been rotating the portfolios towards these sectors that are more resilient to inflationary pressures. An example of this is the current composition of the portfolio of the Welzia Coyuntura fund, our mixed investment fund with a European bias, where we have companies such as Air liquide, which has in its contracts the ability to pass on the increase in energy costs to its customers.
Another company with great pricing power that we have in our portfolio is Novo Nordisk, a leader in the insulin segment with a 50% market share. We have also increased the weight in the financial sector in companies such as BNP Paribas and BBVA.
In the portfolio’s fixed income allocations, we can hedge against inflation by investing in inflation-linked bonds and floating bonds. With this positioning we hope to be able to provide greater diversification and control of the risk of the portfolios before an inflationary scenario in the remaining months of the year and throughout 2022. Welzia Coyuntura has a 5-year annualized return of 5.41% and is one of the 5 most profitable Spanish funds in the Euro Mixed Equity category according to Inverco (data at the end of October 2021).
*** José Gregori, manager of Welzia Coyuntura.