Inflation focus for equity fund

Inflation can mean very different things to different companies. For issuers with pricing power, for example, the higher input prices lead to expanding sales and fatter margins, but those without pricing power may find themselves uncomfortably squeezed.

Of course, rampant, broad-based inflation is no good to anyone. But that’s not the situation we find ourselves in today. Rather, there are pockets of inflation spread around the globe, fuelled by a growing middle class in the developing world and loose monetary policy in western countries.

One investment firm making the most of this environment is GAM, the London-based fund manager, which last year saw its Star Global Equity Inflation Focus Fund return 40 percent. Previously available only to GAM’s private clients, the fund has recently been opened up to the public, with the portfolio being run by US investment adviser Manning & Napier.

‘GAM’s private client business came to us and asked how we would manage an equity portfolio able to provide protection against inflation,’ says Greg Woodard, portfolio strategist at Manning & Napier.

The fund is flexible as ‘you may have low inflation in certain areas of the world, high inflation elsewhere,’ he explains. ‘You may have different cycles, and different companies are going to benefit at different times in those cycles.’

The fund has a global mandate, not for the purpose of achieving global diversification, but rather to not limit it to any particular region, so it can focus on regions where opportunities present themselves.

Within this broad view, Manning & Napier has identified six inflation themes it is trying to play: agriculture (which it calls ‘agflation’), fuel (which it calls ‘fuelflation’), materials, metals & mining, water, transportation and real estate. Of this list, the greatest emphasis has been placed on agflation and fuelflation, which can each be weighted up to 30 percent of the portfolio.

Each of the inflation themes derives from a supply/demand imbalance. Take agflation, for example: rising prices in the agricultural market are largely being driven by secular demand trends in the emerging markets, where the growing middle classes are eating a greater quantity and variety of food.

As a simple example of how eating habits are changing, Woodard points to the fact that millions of people in the developing world are moving from one meal a day to two. ‘That is putting strains on the global food supply,’ he states.

Meanwhile, the demand/supply imbalance has been exacerbated by poor harvests and severe weather conditions in some of the world’s biggest exporters of food, such as Brazil and Australia.

Playing the cycle
Manning & Napier aims to benefit across the inflationary cycle, as price pressure moves from the producers of an asset to the consumers. ‘Early on in the cycle, you want to own what we call the producers, the companies that produce the asset that is undervalued, because that asset is going to go up,’ explains Woodard.

‘Once the asset price starts to go up, you want to shift out and start to buy the suppliers. In the case of agflation, these are the firms that allow farmers to bring on new supplies of food. Later in the cycle you want to shift to the consumer companies, like meat producers or cereal producers.’

Last year, Manning & Napier held a ‘producer’ company called Black Earth Farms, which owns and develops farmland in Russia’s fertile Black Earth region in the west of the country. As the fund manager moved through the agflation cycle, it sold out of Black Earth Farms and took stakes in agricultural suppliers, such as Titan International, the NYSE-listed manufacturer of tires and wheels for farm vehicles.

‘It is in a very consolidated industry – it almost acts as a monopoly,’ Woodard says of Titan. ‘Bridgestone and Goodyear have, in effect, pulled out of making these giant tires, some of which are more than 10 feet in diameter.’ Other companies he holds today include Monsanto, a seed company that helps farmers improve their crop yields and also grow crops in hostile conditions.

When it comes to consumer companies at the end of the cycle, Woodard is looking for the strongest firms in their market, as these will be most able to pass on rising input prices to their customers. Companies that can’t do this – those with weaker brands or products – may well go bust, further boosting the market leaders.

Under the theme of fuelflation, consumer companies would be firms such as FedEx and UPS, which need fuel to power their vast logistics networks, explains Woodard. ‘Their weaker competitors are getting disseminated and FedEx and UPS are gaining market share in that more difficult environment,’ he points out.

The team
If you meet an analyst from Manning & Napier, it will most likely be one of the sector specialists conducting bottom-up research. There are six groups of specialists in all, covering technology, life sciences and healthcare, real estate, services (including financial services and utilities) and materials.

The fund manager takes the view that sector analysts should be global experts, as companies compete in a global marketplace. As a result, IROs and management teams should be prepped to discuss industry trends from an international perspective.

Manning & Napier also employs three top-down macro groups, which feed ideas to the bottom-up stock pickers, so expect to be quizzed on how macroeconomic factors are affecting your business as well.

Woodard says there is no rule that analysts have to meet a firm before investing, but in many cases some kind of conversation will take place with an issuer’s management before a recommendation is made to buy the stock. Analysts will also speak to a company’s competitors and other industry experts to give them a more complete picture of the investment opportunity, he adds.

For Woodard and his team, inflation comes in all shapes and sizes, but there is one basic trait they look for in the companies they invest in. ‘This mandate is really focused on companies that have pricing power,’ he concludes.