Equities vs cash in an inflationary regime
By way of illustration, we can look at the relative performance of equities (we use S&P 500 in GBP terms as a proxy) and cash during the period of high inflation in the UK from December 1972.
Over five years, an allocation to equities delivered a price return of -1.3 per cent (-0.3 per cent annualised) while cash lost -54 per cent of its purchasing power (14.2 per cent average annualised inflation).
Over 10 years, an allocation to equities gave a price return of +72.9 per cent (+5.6 per cent annualised) while cash lost -73 per cent of its purchasing power (12.4 per cent average annualised inflation).
And over 20 years, an allocation to equities delivered a price return of +473.7 per cent (+9.1 per cent annualised) while cash lost -84 per cent of its purchasing power (8.8 per cent average annualised inflation).
What we see is that staying invested and allocating to equities for the short, medium and long term in an inflationary regime can deliver preservation of purchasing power and capital growth.
Understanding the concept of equity duration
What do we mean by equity duration? In technical terms, the duration of an equity is the sensitivity of the price of that equity to any change in interest rates.
More practically, equity duration can be defined as the number of years it takes for an investor to recoup the price paid for a share from cash flows generated by that same share, that is, dividends.
The concept is useful when it comes to visualising the shape of future earnings of a particular share and its corresponding sensitivity to changes in interest rates in order to value those earnings in today’s money. And that is a particularly useful analytical tool in an inflationary regime when purchasing power and the value of money become more dynamic.
A conceptual measure
Essentially, it is the same calculation as that which is used for bond duration, but instead of measuring a stream of fixed interest payments, you are measuring a stream of earnings or dividend payments and therefore it is a conceptual tool rather than a definitive one.
There is no published equity duration figure for a particular equity because it depends on the analytical view of a company’s earnings profile and dividend policy.
Duration length and its implications
Equities that derive the greater proportion of market value from near-term income and forecast dividends (discounted back into today’s terms) have what would be described as short duration.
Equities that derive the greater proportion of market value from long-term income and potential dividends (discounted back into today’s terms) have what would be described as long duration.
