Stocks, bonds best bets in high-inflation environment

  • 2004-10-20
  • By Michelle McGagh
RIGA - The common presumption that it's best to invest in this robust corner of the EU continent has been turned on its head, as annual inflation in Latvia is barreling ahead at 7.8 percent and set to rise even higher. With prices rising that fast, the number of investment possibilities is limited. Bank deposits offer only 3.5 percent, while putting money into a real estate market that resembles a well-blown bubble risks disaster.

Analysts say that in the current environment investing in stocks, bonds and index funds would be wisest. But as always, each investor must choose depending on his strategic needs.

"The advantage [of stocks] is in choosing a suitable strategy that best answers your requirements. Stock selection and its weight in portfolio are up to an investor that gives freedom of choice," says an investment manager as Unibanka who did not want to be named.

As a long-term investment, stocks are best, he added, especially if one can buy at a reduced price - which often happens in a high-inflation environment. Buying undervalued shares in an inflated market will, together with dividends, pay off over the long run.

Another option is index funds. This is especially cost efficient, as the funds are determined by a public index and therefore incur minimal fund management costs. However, like stocks, index funds, which are designed to match the market and not beat it, are more dynamic and offer a higher return, but they are more risky, reminds the Unibanka manager.

If debt is your cup of tea, then buying individual bonds can be an attractive investment option, though buying into a bond fund is a safer bet. Although inflation jeopardizes any fixed income stream, bond funds carry far less risk. "Bonds, when we are talking about governmental ones, guarantee to you a fixed return after predetermined time. Stability and safety are advantages of the bond fund investment. Pension funds usually use bond portfolios for investments," says the investment manager.

In the meantime, it seems that the rate of inflation in Latvia will not decrease any time soon, and the EU accession is somewhat to blame. "I think [accession] was actually the key factor that resulted in the high inflation. The Noble Prize in economics this year went to a team that proved that people's expectation matters most for inflation changes. In Latvia people expected prices to grow and so it happened. So inflation grew along with expectations. Monetary policy has less power than people's expectations," says the fund manager.

While people's expectations in the EU remain high, inflation will not fall as fast as many people hope. "As theory goes, your current inflation expectations are based on the past. So in the past we have high inflation, and people will not expect it to go down. There is some room for price convergence with other EU countries. Also, starting from the beginning of the new year inflation is expected to grow as the lat will be pegged to the euro."

Still, inflation is not a death-knell for investing in Latvia.

"None of the investments can guarantee you that they will beat the inflation rate. Investment in a country with a higher inflation than even your home country can pay off," said the Unibanka manager.