Investment options in inflationary environment
ACCORDING to the Public Accounting and Auditor’s Board of Zimbabwe, all local companies needed to adopt hyperinflation accounting for post-July 1 2019 results as the country was in a hyper-inflationary environment.
As at the date of writing this article, annual inflation for March 2020 was 676,4 percent, as it shows little signs of slowing down.
Zimbabwe’s hyperinflation is not a new phenomenon.
According to economist Erik Bostrom, since 1990, it has affected 28 countries in the last 25 years and occurred 37 times.
It can be drawn from this statistical summary that indeed, history does have a tendency to repeat itself and, in that respect, Zimbabwe is no exception. Some valuable lessons can thus be extracted from the experiences of these countries and that of Zimbabwe, which has experienced hyperinflation twice in the last decade.
We should point out that a number of independent economists did predict a path towards hyperinflation the moment bond notes were introduced as a pseudo currency in 2016.
It took no less than two years before high inflation numbers decimated the local currency.
This article aims to suggest investment strategies that have a higher likelihood of success in a hyperinflationary environment, with a particular focus on Zimbabwe.
Seeing the signs
As is the case in most hyper-inflationary environments, cash and near-cash assets are the most vulnerable classes to loss of value.
This is the single asset class that suffers the most loss of value in a hyper-inflationary environment, but in most cases remains the medium of exchange during the period.
As inflation reaches hyperinflation levels, human behaviour confirms this fact as individuals store their wealth in hard currencies and other non-cash assets in an effort to preserve value as they shun their own domestic currency.
Other tell-tale signs of a possibly worsening inflationary environment can be observed by looking at the speed and quality with which public information is distributed.
In the case of Zimbabwe, whenever there are delays in the publication of public expenditure numbers, money supply statistics and even the publication of official inflation numbers, these are usually signs that the Government may be attempting to mask the statistics or hide the fact of significant money supply growth in the absence of production
Pockets of real return
In periods of hyperinflation, an investor would be best placed to divest from near-cash and cash assets and into assets that reprice themselves with inflation. Some of these asset classes include property, equity and even inventory and prepayments in the case of businesses.
Whilst some of these assets (property, equities, inventory and prepayments) may not directly price accordingly with inflation in the immediate term, in the medium to long run they usually outpace or at least keep pace with inflation.
There have been documented abnormal real returns from acquiring equities and properties towards the tail end of hyperinflation when assets are hugely discounted due to the poor environment, including benefiting when the country adopts inflation-busting policies and rapid re-pricing of assets occurs.
The trick, however, is in timing the tail end of inflation.
One hazard to warn is that asset selection is quite key in equities as a number of businesses can buckle during hyper-inflationary days if they do not have dynamic management and or their statement of financial position cannot sustain the company over the hyper-inflationary period.
Generally, the observation from the 28 countries has been to take as much fixed rate debt in the devaluing currency and convert them into assets like houses, equity or precious metals.
The most beneficial strategy is using debt to acquire an asset like a farm or mine that produces more or acquiring a business such as a factory that is productive
Hazards to look out for
The worst asset one can invest in during hyperinflation is holding cash, fixed rate bonds or money market instruments that yield a return that is lower than the inflation rate.
In the case of Zimbabwe, it would be investing in current treasury and money market instruments, which have returns of circa 0-15 percent, which is lower than the annual inflation rate of 676,4 percent as at March 2020. Holding such assets actually translates to negative real returns.
Listed companies that have poor solvency positions and generate poor cashflows are another potential hazards as these companies rapidly erode their asset base during hyperinflation, exposing themselves to potential closures and liquidations. One common question asked by many an investor is the question of holding foreign currency during hyper-inflationary times.
Whilst holding foreign currency is an excellent way of preserving value, it is not a desirable investment strategy as one still needs to generate cashflows in order to survive.
Failure to generate cashflows ultimately results in one then using these foreign reserves or savings to the point of depletion should the hyper-inflationary period extend for an unanticipated timeframe.
Conclusion
On the downside, in the absence of certain regulatory and policy changes, hyperinflation can last for extended periods of time.
According to the International Monetary Fund, hyper-inflationary periods on average last 14 years, with an average annual inflation rate of 893 percent for the severe cases and 45 percent for the less severe cases.
On the upside, it is surprising to note that people with sizeable asset bases and access to debt during hyperinflation can usually fare better when hyperinflation ends than when they entered into it. The same can be said for ordinary citizens. However, this takes an appropriate investment strategy and market intelligence on their part.
On a macro scale, such periods of hyperinflation are usually followed by significant political, regulatory and socio-economic changes that are usually necessary to create an environment for sustainable economic growth.
◆ SIDEWAOS is an independent research consultancy firm. Views shared here are those of SIDEWAOS and not the views of The Sunday Mail Business. Send feedback to sidewaos@outlook.com. .