The Inflation hedging properties of South African asset classes
Inflation poses a serious threat to the purchasing power of assets over time. This study examines the short and long-term inflation hedging capabilities of South African equities, bonds, listed property and cash - and compares them to foreign substitutes. The aim of this study is to investigate the inflation hedging capabilities of four primary asset classes in both domestic and foreign contexts: equities, bonds, listed real estate and cash. More specifically, this study evaluates how well each asset class performs with respect to South African inflation, and through a comparative analysis of the results, identifies which asset class may be regarded as the superior inflation hedge. Moreover, the inflation hedging capabilities of domestic assets are compared to foreign asset classes in an attempt to provide investors with valuable insights as to whether domestic and/or foreign asset classes offer better protection against the harmful effects of inflation. Finally, the study demonstrates how well these asset classes perform with respect to inflation over short and long-run horizons. The data used in this study comprises total return indices which portray a more accurate picture of an investor's return. The period 1999-2015 forms the range within which data for all domestic and foreign asset classes are available, and thus constitutes the sample period used in this study's comparative analysis. Excluding domestic bonds on the basis of data availability, the comparative analysis of domestic asset classes, dates back to 1965. This study makes use of the following tests: Pearson correlations, Augmented Dickey-Fuller, Phillips-Perron, Granger causality, OLS regression, VAR and Impulse Response Functions, and Cointegration. This study finds evidence in support of a negative contemporaneous and lagged relationship between domestic and foreign equities, and South African inflation in the short-run (also widely recognised as the "inverted Fisher effect"). Domestic bonds, property and cash were found to provide a partial inflation hedge in the short-run. Cash was found to exhibit the strongest hedging properties. On the other hand, foreign bonds, property and cash were found to be anti-inflation hedges with contemporaneous and lagged inflation. However, although foreign asset classes do not offer protection against contemporaneously or lagged inflation, they do provide a leading return prior to inflation manifesting. Consequently, if profits are taken early enough it can provide investors with an inflation hedge. This is important for local investors to be aware of when deciding to invest in foreign asset classes with the goal of hedging against inflation. Utilising the Engle- Granger Cointegration test, the findings of this study suggest that both domestic and foreign asset classes do not display a long-term relationship with inflation. This suggests that both domestic and foreign asset classes are anti-inflation hedges, since neither covary positively with inflation in the long-run. One major implication of these findings is that investment firms, whose benchmarks' contain consumer price indices (CPI), rely on the fact that the average returns of various asset classes exceed the average inflation rate in the long run, rather than being good inflation hedges (viz. co-movement with inflation).
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