Three stocks to safeguard your portfolio against inflation
To many investors today the subject of inflation presents three burning questions. 1) When will it really hit? 2) How badly will it hit? 3) How can we prepare our portfolios strategically to make the best of it, and, where possible, profit from it?
VGI Partners latest investor letter for VGI Partners Global Investments (ASX:VG1) raises this topic and describes how owning high-quality businesses that avoid market volatility can safeguard your portfolio against the uncertainty that inflation brings.
In this wire, I pull out some key takeaways from the letter and share three stocks that VGI Partners is picking for an inflationary environment.
The two essential traits
According to the VGI Partners team, who achieved a portfolio return of 25.6% after fees for ASX:VG1 over the year to June 2021, there are two essential traits of a high-quality business that allow it to perform well in an inflationary environment.
The first attribute is a business with pricing power meaning businesses can raise their prices with minimal or no impact on demand for the product.
The second attribute is an ad valorem, or "according to value", pricing model. This means that, rather than charging fixed rates for each product sold or service provided, businesses with ad valorem pricing models charge a percentage of the value of the transaction. This feature can protect these businesses from rising inflation, as revenues increase in line with the value of transactions processed. As the letter outlined:
We have constructed a portfolio of businesses which have either ad valorem pricing models and/or pricing power, which provides them with protection, over the long term, from sustained inflation.
VGI Partners flagged three stocks they believe will be insulated over the long term from periods of sustained inflation, summarised below.
Cie Financiere Richemont (SWX:CFR)
VGI used the example of Richemont as an example of a business with extraordinary pricing power. Richemont, which is listed on the Swiss stock exchange, owns luxury jewellery brands including Cartier and Van Cleef & Arpels. According to VGI, Cartier would be able to increase the prices of their necklaces and bracelets by 10 to 15% over the next two years without it impacting the volume in sales.
Looking through the portfolio today we are confident that our businesses will be able to raise prices, at least in line with inflation, and would see minimal impact to demand.
To prove it to you, in the last twelve months, Cartier's sales have managed to not only stay afloat but rise (and that's in the middle of a pandemic with closed stores). Richemont's jewellery division revenue was up 3% for FY21 - remarkable for shut shops.
In terms of exploring the ad valorem pricing model, VGI used the example of Mastercard. This business is built on taking a clip of all credit and debit card transactions that flow over its network. If the concern of inflation does actualise, the value of goods purchased over the network will increase and Mastercard's revenue will grow.
CME Group (NASDAQ:CME)
VGI also provided the example of CME Group for a company that will not only survive but would thrive in an inflationary environment. CME is the world's largest financial derivatives exchange where market participants must go to hedge their interest rate risk. So, should these participants believe that inflation is a real risk and not just transitory, they will trade derivatives to protect themselves or to speculate. CME will see its volumes increase substantially, which goes to their execution of an ad valorem pricing model.
"Owning CME not only protects us from inflation but allows us to profit from it."
An inflation-proof portfolio
So whether you're looking to inflation-proof your portfolio, or you're just after some of the world's best and biggest, ASX:VG1's portfolio has something for everyone. In their recent letter to investors they also discuss one of their newest portfolio additions and reflections on short selling over the last twelve months. You can read the full letter here.
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