Inflation-beating returns: Are protected growth strategies the answer?

Investors need to apply some caution to their expectations for investment returns as we enter a higher interest rate and inflationary environment over the coming few years, while looking to adopt different investment strategies in an effort to protect the

When markets fell off dramatically in 2008 - returning -23% for the year - there wasn’t an immediate safe haven for investors’ capital as the Federal Reserve and monetary policy committees globally slashed interest rates in an effort to keep economies afloat.

As a result, the usual investment holding bay of cash or near-cash investments hasn’t offered the yields that investors need to remain ahead of inflation.

Is higher risk the answer?

In some ways investors have had little choice but to seek out higher risk assets in order to get higher returns.

Less risky asset classes such as bonds have the added risk of possible capital loss should bond yields increase significantly. This rise in yield leads to a fall in the price of the bond and may well offset income earned from the instrument. A rising inflation environment is likely to put pressure on real returns generated by lower risk assets.

Equity markets have been good overall to investors during a period of sustained volatility, but that is in the past. Investor optimism in equities is not misplaced but it is mostly reflective of the benign return environment that investors find themselves in, with returns from other asset classes struggling to offer inflation-beating returns.

Headwinds looming

The markets are quite close to fair value or even slightly expensive. South Africa, along with many other economies, finds itself at the bottom of the interest rate cycle. Even with the anticipated increases in interest rates towards the end of this year or early in 2012, investors still face the reality of a low after-tax return from cash as rates will be increasing from a low base.

Broadly within South Africa, the rand strength or weakness in the future will further impact investors. Rand weakness could lead to higher inflation on imported goods, driving local inflation even higher and probably outside the 3 - 6% target range. This in turn could lead to the SARB increasing interest rates yet further than the already anticipated increases for 2011/2012. Unemployment will also remain a broad issue and the country’s ability to generate and sustain job opportunities will certainly impact the local economic environment.

Beating inflation

Investors’ main concerns over the next few years is going to be looking for ways to retain the purchasing power of their investment – searching for yield that offers inflation-beating returns.

Protected growth

Considering investment decisions over the short to medium term, investors could look towards a “protected growth strategy” - investments that have built-in capital protection, such as a capital guarantee on money invested, but still offer exposure to the upside of a market.

Protected growth strategies most often entail partial participation in market or asset class upside, while providing a capital preservation or protection mechanism to offer assistance in protecting against possible market losses.

Following a protected growth strategy may come at the expense of missing out on some of the big upward surges in the market but it equally protects against possible market losses.