The effect of inflation on your money is best demonstrated by trying to run up an escalator that's going down.
Just as you have to do a lot of running merely to stay in the same place, inflation chips and chisels away at your returns, and if you're not even getting inflation-beating returns on your investments, you're not really ahead of the game; you're only going down.
"Inflation," says Patrice Conxicoeur, CEO of Sinopia Asset Management Asia-Pacific, the investment arm of HSBC Global Asset Management, "is the worst enemy of the investor. It eats away at purchasing power, and it creates volatility in markets."
And given the high - and accelerating - inflation rate across the world, and particularly in emerging markets, investors in these markets are groaning at the prospect of seeing their hard-won money being chomped up by the monster called inflation.
On Monday, HSBC Global Asset Management unveiled perhaps the world's first inflation-linked bond fund as a way for investors to get "positive exposure to inflation." Whereas conventional bonds, where the principal that's repaid upon maturity remains unchanged, an inflation-linked bond has its principal indexed to inflation. As a result, the principal and the coupon payment will increase over time in an inflationary environment.
"The Emerging Markets Inflation-Linked Bond will offer investors a chance to benefit from inflation, not suffer from it," says Conxicoeur.
"In times of market volatility, investors tend to flock to bonds as a safe haven," he adds. "But although bonds may offer stability in this environment, inflation is a serious risk as it reduces the returns from bonds over time. Emerging market inflation-linked bonds help investors hedge against inflation by paying them the principal and coupon at an inflation-adjusted amount."
The fund aims to provide capital growth and quarterly dividend payouts by investing primarily in inflation-linked bonds issued by the governments and quasi-governments of emerging markets.
"In periods of inflation acceleration, such as are expected, inflation-linked bonds outperform other asset classes."
Emerging market currencies have been appreciating strongly on the back of stronger fundamentals, such as ample foreign reserves and improving current account deficits.
Given that this trend is likely to continue, and in fact could receive a boost from potentially higher interest rates, the emerging markets inflation-linked bonds denominated in local currencies could benefit from this trend.
Higher inflation may inspire two kinds of policy actions from governments: a raising of interest rates, and currency management.
HSBC pan-Asia economist Peter Morgan points out that both these responses have largely negative implications for traditional asset classes - equities, nominal bonds and commodities.
"Inflationary pressure remains strong in emerging markets, and although growth in emerging markets is likely to moderate due to the global slowdown, it will still be strong."
Conxicoeur concedes that the possibility of a slow-down in inflation (or even a slip-back to deflation) is a risk. But he argues that it's not a probable eventuality because unlike interest rates and currencies, inflation trends do not change course suddenly. In any case, he argues, fund managers will tweak their portfolio to prevailing circumstances by increasing their holdings in markets where inflation trends are rising and reducing holdings in markets where inflation is easing.
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