How to ride the return of inflation
A weak pound will boost the cost of living. Investors can benefit if they adopt the right strategy, writes Sam Brodbeck
Asharp fall in the value of the pound since Britain voted to leave the EU and a recovery in the price of oil mean that savers’ greatest enemy – inflation – is about to make a comeback. Opinions differ as to the level it will reach and whether it can be sustained, but investors should be planning to hold the right assets to guard against any havoc caused by rising prices.
The Governor of the Bank of England, Mark Carney, has already heaped pressure on savers by cutting the Bank Rate to a new record low, rapidly followed by the banks. Unfortunately, there is no guarantee that this will be the end of it as Mr Carney’s deputy, Ben Broadbent, has signalled that further cuts could be made before the end of the year.
Interest rate cuts coupled with inflation make a deadly combination and doing nothing could see your hard-won investment gains slowly eroded.
In the wake of the referendum the pound crashed to a 30-year low against the dollar – at the start of June £1 was worth a shade under $1.50 and is now hovering near $1.30.
The weak pound has helped to push up the FTSE 100 index of the largest companies in the UK – many of these firms operate internationally and have benefited as their goods become cheaper and their overseas earnings appreciate in sterling terms – but the spectre of inflation now looms large as imported goods become more expensive.
Fortunately, economists are not predicting the kind of runaway inflation seen in Britain in the Seventies, when attempts by the government to control wages and prices led a miners’ strike, power cuts and the three-day week.
Experts say this latest bout of inflation is more likely to hover around the Bank of England’s target of 2pc – a level not seen since 2013.
Anthony Gillham, of Old Mutual Global Investors, said a combination of a weakening pound, the pickup in the oil price and growth in UK earnings meant markets were expecting a rise sooner rather than later.
Mr. Gillham said that, using the inflation-linked bond market as a proxy, annual inflation was predicted to run at 2.6pc on average for the next five years. But even if the rise in the cost of living proves to be short lived, investors will want to position themselves to boost their portfolio while the opportunity is there.
In a market of rising prices, cash and bonds are the most vulnerable assets. Investing in the stock market, however, is not necessarily a foolproof way to deal with inflation as some companies are more capable than others of passing on higher costs and safeguarding profit margins.
Adrian Lowcock of investment company Architas said firms that sell staple goods – such as supermarkets, tobacco and utilities – could raise customers’ prices with little drop in demand. Stocks in businesses that sell luxury items, expensive electronic equipment and holidays were likely to suffer far more.
He picked out Neil Woodford’s Equity Income fund as a way to invest in resilient firms because of its focus on strong companies with growing sales and high exposure to traditional “defensive” sectors such as tobacco and pharmaceutical companies.
He also favoured the M&G Inflation Linked Corporate Bond fund, which, as the name suggests, invests in bonds whose returns are pegged to the rate of inflation.
Jason Hollands, of fund broker Tilney Bestinvest, recommended focusing on growth businesses and “real assets” such as gold or land where “the supply can’t just be increased out of thin air”, unlike money.
He added: “There are other types of investment that very directly include inflation-proofing, such as inflation-linked bonds or exposure to infrastructure projects where contracts often include adjustments for inflation.”
Infrastructure is an age-old inflationbusting investment but Mr Hollands said investment trusts in this area were expensive at the moment – they are trading at a premium, meaning the trust’s value is higher than that of its assets. An alternative is to invest through infrastructure shares; Mr Hollands picked Lazard’s Global Listed Infrastructure Equities fund.
Mark Meldon, a financial adviser at Meldon & Co, said he advised clients against trying to predict economic trends. Instead, he recommended holding a mixture of assets designed to perform whether the economy is in boom or bust, or whether prices rise or fall. He said investors should look for exposure to real estate, index-linked bonds and commodities to guard against inflation.
He said: “I recommend people buy exposure to real estate through investment trusts such as Picton Property Income and F&C Real Estate Investment. I like this approach because with investment trusts managers don’t have to sell bricks and mortar to get cash to pay redemptions.”
Several of the largest conventional commercial property funds – including those run by M&G, Aviva Investors and Standard Life – were forced to block investors from withdrawing their cash following the referendum.
‘Certain investments directly include inflation-proofing’
A return to 1970s levels of inflation is unlikely. Above, striking miners in Wales