A child of inflationary times, Lance Wiggs reflects on inflation’s impact on real returns
With interest rates remaining high, at least versus recent norms, the attractiveness of technology investing has been questioned. Why should people look for 15-25% returns from a venture funds, when even banks are paying 5% or 6%?
Quite simply, we have returned to the days when we care about the difference between real and nominal returns. Nominal returns are simple dollar numbers that are not adjusted for inflation. Real returns consider the impact of inflation.
With a prevailing inflation rate of 7%, $100 invested at 5% for a year would have a nominal value, before tax, of $105, but a real value of closer to $98. That’s a loss. That’s also before tax. At a tax rate of 28%, the real result is $97 in today’s money (real) terms.
Extrapolate that out for 10 years and $100 of today’s money would be $197 in ten-year-time money, but the 5% interest would only have returned $142 after tax or $0.72 cents in today’s terms.
However, if you invested instead in a security that delivers 15% compounded return, which (currently) would not attract any New Zealand tax, the return would be $4.05 in nominal terms, or $2.06 in real terms.
The combination of inflation, compound returns and, though we have not covered it, diversification, are all critical to consider in times of inflation. Growing up, as I did, in the 1970s and 1980s, I have a genuine aversion to investing into products that are not inflation resistant.
At Punakaiki Fund, our companies are, of course, exposed to cost inflation. But, by and large, they control the price of what they sell, and that provides built-in inflation resistance. We should therefore generally expect companies to continue to deliver in real terms, not just nominal terms, and that should flow through to Punakaiki Fund investor returns.
The challenging global times are making trading uncertain for some companies, potentially difficult for others, and very strong for yet others. Meanwhile, the rapid emergence of AI technology that actually works well is providing ample opportunities for companies to improve their effectiveness internally and for their clients. It will be an interesting year.
As Punakaiki Fund looks to the next ten years, we can look back on a strong investment track record, take stock of an impressive investment portfolio, and admire the scars from our well-earned experience. We are confident in where we are and have options in front of us as we consider the future.