Investing to beat inflation

20th February 2013

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The mix of a stagnant economy and persistent inflation is a tricky one for investors to navigate, but there are methods to minimise the eroding effect of rising prices on your portfolio. So which assets should you pick asks financial journalist Harriet Meyer.

Guarding your wealth from the ravages of inflation is vital, stresses Tom Stevenson, investment director at Fidelity Worldwide Investment. “People tend to underestimate its destructive power,” he said. “But remember that an inflation rate of 7 per cent will halve the value of your income in just 10 years, which is potentially catastrophic in an environment in which many pensioners have locked into extremely low annuity rates.”

Many experts expect inflation to soar above its current level of 2.7 per cent, or at least remain stubbornly high for the next few years, as the Bank of England’s quarterly inflation report warned, leaving investors particularly exposed to its impact if they stick to saving in cash and many fixed-interest areas.

Thomas Becket, chief investment officer at PSigma, said: “Our concerns are that ultimately the hyperactive and loose behaviour of global central banks combined with emerging market consumers’ desire for commodities will create intense inflationary pulses.”

So what options are there for investors wanting to combat inflation? Turning to inflation-linked options, Juliet Schooling, head of research at Chelsea Financial Services, says: “Sadly UK inflation-linked bonds are prohibitively expensive, but fortunately we have been able to find relatively moderately priced inflation-linked bonds in global markets, which we access through the Standard Life Global Index-Linked fund.”

Meanwhile, Becket favours the M&G Inflation Linked Corporate Bond fund. “We seeded this fund in late 2011, and it has provided efficient inflation protection and good risk-adjusted returns,” he said.

The stock market can prove to be a good inflation hedge, with equities benefitting in a modest inflationary environment, stressed Stevenson. “Inflation rising to about 4 per cent is often associated with rising equity valuations because it usually means that the economy is improving.” However, he adds that if inflation soars beyond this point, valuations could fall back again, as this may be associated with an increase in interest rates.

To get your money earning an income that stands a fighting chance of beating inflation, consider good quality dividend paying stocks, allowing you to benefit from a real claim on a company’s assets and its cashflow.

Since March 2009 the FTSE UK Equity Income Index has returned 125.9 per cent in both dividends and capital growth. Adrian Lowcock, senior investment adviser at Hargreaves Lansdown, recommends the Artemis Income fund, paying an attractive dividend of 4.4 per cent, to take advantage of this trend. “The dividend return outstrips inflation, with added potential for capital growth,” he said.

This fund focuses on companies with the cash flow to sustain and grow dividends above the rate of inflation, with stock in defensive sectors such as utilities, energy, foods and pharmaceuticals a good bet as these can raise prices effectively within an inflationary environment.

Infrastructure also provides opportunities to protect from inflation, added Gavin Haynes, investment director at Whitechurch Securities. “This is broadly defined as investing in companies whose assets include roads and railways, airport services, marine ports and services, utilities, and oil and gas transportation,” he said.

Yet some fund managers, such as Sebastian Lyon, manger of the Troy Trojan fund, aren’t ruling out a spell of deflation – although he ultimately believes the actions of Western governments will ultimately end in higher inflation.

Lowcock says: “He has prepared for both eventualities, believing his equity and bond exposure should help to offset the effects of high inflation, while in a deflationary environment, when prices of goods and services are falling, cash should hold its value better than other assets. Gold, traditionally considered a hedge against inflation, could also provide shelter against deflation.”

However, gold and many other commodities have already seen a prolonged period of rising prices, and the jury is out on whether this can continue. Yet for investors willing to take some risk, there are other options.

For example, commodities also have traditionally strong inflation-proofing characteristics. Becket favours positions in commodity funds, such as Investec Enhanced Natural Resources fund for inflation hedging purposes.

Investors could consider themes that are bearing the brunt of inflation, such as energy or agriculture. Schooling recommends Baring Global Agriculture and Investec Global Energy funds as part of a portfolio to take advantage of rises in these areas.

Another option is a fund that markets itself as performing in a variety of economic conditions.

Absolute return funds make use of sophisticated investment techniques with the aim of producing attractive returns whatever the environment. While many have fallen out of favour, an example of a steady performer is Standard Life Guaranteed Absolute Return Strategies (Gars). This is known for investing across bonds, currencies and equities as well as esoteric areas such as interest rates.

“The investment areas and financial techniques that the fund uses are truly diverse, both in terms of asset classes and globally, ranging from long-only traditional investing in equities and bonds to making calls on currency, inflation, and mortality, for example,” said Haynes. However, owing to the complex nature of these funds it is important to understand where they invest and what strategies will be employed before ploughing your capital into them.

Finally, if you’re keen to steer away from the stock market and a traditionally diversified portfolio, you could opt for an alternative asset that you believe has the power to profit in inflationary times. “In this case, always buy the best, scarcest assets you can and especially things that they can’t make any more,” said Stevenson. “Land, prime property in world-class cities, wine and classic cars can all do well in inflationary environments – but the latter two are also prone to horrendous busts as well as booms.”

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