David Souccar, co-portfolio manager of the Virtus Vontobel Foreign Opportunities Fund, discusses the risks of hedging inflation with cyclicals and commodities and how quality companies can withstand inflationary pressures.
Key takeaways from this discussion:
- Companies with pricing power can help defend against inflation. Business models like Mastercard take a percentage of revenues from customers. Thus, the company’s revenues increase when prices increase. With mainly fixed costs and a low proportion of labor costs, Mastercard can help protect against inflation but also has operating leverage.
- In the consumer staples and discretionary sectors, Nestlé and LVMH are examples of brands that have pricing power. In industrials, Rentokil provides pest control, a necessary service where limited price increases go unnoticed.
- In a scenario where high inflation persists, cyclical areas like banks and commodities, however, will not protect well against inflation. They have limited pricing power and commodity industries, being capital intensive, tend to struggle to protect operating margins.
- Quality stocks are positioned to perform well in a rising interest rate environment. If rates increase because of a healthy economy, there should be greater demand, which is good for growth businesses. And if rates rise because of inflation, quality companies can maintain profitability and increase their relative strength vis-a-vis the overall market.
- There are different “shades of quality” investing, which can lead to different levels of risk and return. Investors should know what type of quality strategy they are invested in. We believe the best quality strategy offers a solid defense and lower risk exposure but can also outperform over a full market cycle.
- In Europe, it is important to separate the economy and politics from investment opportunities. The continent is home to many world-leading businesses that are driven by secular trends. It is possible to find European businesses like those in the U.S. but at better valuations.
- Technology that was not tested before the COVID-19 pandemic is working seamlessly, from remote working to vaccine development. In international markets, we believe there are great opportunities in technology that can introduce new ways of approaching older industries.
The commentary is the opinion of Vontobel Asset Management. This material has been prepared using sources of information generally believed to be reliable; however, its accuracy is not guaranteed. Opinions represented are subject to change and should not be considered investment advice or an offer of securities.
Past performance is not an indication of future results.
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