What is the best hedge against inflation?
If you have savings of RM100,000 or RM1 million, how would you use this amount of money to preserve your wealth?
This is a legitimate but increasingly pressing question as, globally, countries around the world are facing inflationary pressures due to the effects of accommodative monetary policies over the past couple of years.
While not everyone is passionate about financial markets or macroeconomics, most would be concerned if they knew that the value of their money or hard-earned savings is eroding more and more every day through no fault of their own. go.
The common method adopted by most would be to assess the value of the ringgit against foreign currencies such as the US dollar, Singapore dollar, British pound, etc. Another would be the actual purchasing power of your money. Combining the two, it becomes the formula for purchasing power parity.
I wrote an article in this column last year using the Big Mac index to illustrate inflationary effects. Today, when inflation is already here, I prefer to dwell on how individuals can protect their savings from inflation itself.
Some will say that they live in isolation and would hardly be affected even if the ringgit weakens significantly. However, even one who does not travel abroad and lives entirely within the domestic ecosystem cannot escape the impact of inflation.
As the global economy is a huge interconnected web, connected through global trade, inflationary pressure can be imported through the transaction of goods or the fact that our country has external debts. There is no absolute way to shield it in its entirety.
The ceiling price on basic necessities and the list of controlled items are what the government of the day does to provide some level of protection for citizens, but if market forces react otherwise, government intervention in itself will not is not enough to regrow. This is proven even in the strictest communist or socialist regime in the world, such as North Korea.
The only way to hedge against inflation is to engage in some form of investment. In the past, real estate has always been recognized as one of the best asset classes for preserving wealth and protecting against inflation. This age-old wisdom has survived through thousands of years and civilizations.
New asset class
As society evolves and the modern economy takes shape, there is now the creation of a new class of assets that in the past simply did not exist or would have no sense to invest substantially. The most common forms of investment are bonds, gold, fixed deposits and stocks.
Next come mutual funds and index funds. Exchange-traded funds have become extremely popular in recent years, especially when returns from active investments have not provided the same type of return as they once did.
This has gained traction for those who are mostly passive investors or don’t have the time to do individual stock picking. Yet despite all the asset classes mentioned above, they are all considered relatively acceptable to most people.
With Millennials and Generation Z entering the workforce, technology has taken center stage in every aspect of our lives, even when it comes to asset classes. Cryptocurrency, non-fungible tokens (NFTs) and digital assets have made their way into traditional financial markets where investment banks, which traditionally scoff at these assets, are now part of the frenzy.
Proponents of cryptocurrency, for example, go so far as to call it an inflation hedge or a hedge against “fiat money” or “new gold.”
The traditional asset classes described above are considered obsolete by the new generation of investors, whoever they are and wherever they come from. I do not wish to debate the usefulness and viability of cryptocurrency, NFTs or digital assets. However, the big question for me is: what really constitutes inflation protection?
For an asset class to be an inflation hedge, the most fundamental aspect is that the asset class consistently outperform annual inflationary pressure. For example, if the inflation rate is 4% per year over 10 years, the asset class in which one invests must consistently outperform 4% per year over the same period.
This asset class will then effectively hedge and protect the value of your money over a substantial duration.
The challenge is to find an asset class suited to their risk tolerance, investment horizon and financial capacity. This is why there are many varieties of asset classes in the financial markets which serve different purposes.
Bonds and gold are good for those with a low appetite for risk but not expecting spectacular returns from these asset classes. In fact, many have wondered if bonds and gold can still hold their value, although this has been proven in the past during wars and turbulent times.
Then there are newer and more interesting physical and luxury items that are not part of the financial markets and seemed to hold their value very well. Limited edition Lego sets, select Hermès and Chanel handbags as well as top luxury watch brands such as Patek Philippe, Audemars Piguet and Rolex are such examples.
An unopened Lego set offers an average annual return of 11%. A Hermes Birkin saw an average annual price increase of 14% from 1980 to 2015. This compares to returns for gold at -2.1% and the S&P 500 at 11.7% over the same period.
For the Chanel Classic Medium Flap bag, the price has increased over the past 31 years, from $1,150 (RM4,817) in 1990 to $8,800 (RM36,858) in 2021. This gives an average annual return of 21.4% and a compound annual growth rate of 6.8% over the entire period.
If we look at watches, the retail price of stainless steel sports watches has gone crazy in recent years. A Phillipe Patek Nautilus, which sold for US$3,100 (RM12,985) in 1976 when it was launched, sells for US$35,000 (RM146,485) today.
What is scarier is the secondary market or gray market price for these luxury goods due to the sheer difficulty of getting one at retail.
A standard size 25 Hermes Birkin sells for around $10,000 (RM41,885), but on the secondary market it can go up to $25,000 (RM104,713). The Patek Nautilus on a gray market fetches nearly US$175,000 (RM733,000). The classic date steel Rolex Submariner, which sells for US$10,800 (RM45,236), commands a huge gray market premium at around US$20,000 (RM83,770).
Some would argue that this is the tactical strategy of ultra-luxury brands to restrict supply and cause a shortage of demand in order to drive up the price, making it a highly desirable product.
However, the counter argument is the fact that these high end luxury brands are handcrafted and require hours to produce the finished product. Limited resources coupled with the need to ensure quality also limit supply.
Faced with a rising affluent class and a rising upper middle class globally, these luxury brands are naturally becoming highly sought after. Once the second-hand market is able to preserve value, it becomes a hedge against inflation.
My biggest conclusion, however, is not which asset class would be the best inflation hedge. On the contrary, even within each asset class, it requires homework, due diligence and careful investment selection to preserve wealth. Making the right decision to buy or invest takes time and effort.
All that glitters is not gold and in this case, some steel watches can be worth more than a pure gold watch. So pick the asset class you understand best and would be happy to hold over time in the face of inflation.
Ng Zhu Hann is the author of “Once Upon a Time in Bursa”. He is a lawyer and former chief strategist of Fortune 500 Corp. The opinions expressed here are those of the author.