Reassessing the Inflation Toolkit – Investors’ Chronicle
- With the action of central banks, the investment case changes for certain assets “sheltered from inflation”
- We take a look at some problematic cases and some surprising avenues to an inflation-proof portfolio.
As 2021 draws to a close, sound bites about âtransientâ inflation give way to central bank action. The Bank of England has put in place a surprise interest rate hike at the same time as the Federal Reserve is accelerating a plan to end its bond buying program. Not all central banks are following suit, but for UK investors, a combination of monetary tightening and high inflation is raising the bar higher. Even though the Omicron variant dampens economic activity and ultimately has the same effect on prices, now is a good time to reassess the tools available to the cautious investor in the face of inflation.
Despite the double whammy of tighter monetary policy and rising prices, some remain relaxed about the outlook for fixed income. Chris Iggo, chief investment officer for core investments at Axa Investment Managers, notes that the tightening is starting from a “very accommodating base” and adds that the upward cycle is expected to end with interest rates still at rock bottom. relatively low absolute levels.
But the situation could nonetheless be difficult for bonds, as we recently mentioned. Particular concerns apply to a sub-sector which has been an effective inflation driver in recent months.
Index-linked bonds, whose interest payments are linked to measures of inflation, tend to perform better when inflation expectations rise. Many commentators believe that it was the rising expectations, rather than the price increases themselves, that were the real catalyst for the performance of these assets in 2021.
If interest rate hikes continue in the UK and appear elsewhere, it could be extremely painful for inflation-linked bonds, given their high levels of interest rate sensitivity. Jonathan Owen, portfolio manager for TwentyFour Asset Management, recently said this year’s gains had been “as good as it gets” for such bonds. Writing days before the Bank of England hiked rates, he warned that index-linked bonds were vulnerable not only to higher rates but also to any drop in inflation expectations resulting from a tightening of the market. Monetary Policy.
“If inflation expectations fall as a result of the Bank of England tightening, the subsequent rise in real yields is a double whammy that only impacts linkers,” he said. .
Actions: specialist and generalist
Some stocks offer their own type of protection against higher prices. In terms of sectors, banks are clearly benefiting from the rise in rates. Ryan Hughes of AJ Bell says the ETF space is a simple option: names like the iShares S&P 500 Financials UCITS ETF (UIFS) or the SPDR MSCI World Financials Sector UCITS ETF (WFIN). However, as we recently noted, the potential index changes could leave more payment processors such as Paypal (United States: PYPL) in the financial services category, by diluting the exposure of these funds to banks. More concentrated sector exposures are available through investment funds such as Polar Capital Global Financials (PCFT).
Larger offers should not be struck off. From Special loyalty values ââ(FSV) at SchrÃ¶der recovery (GB00BDD2F190), value funds capture relevant sector exposures. UK equity income funds will often do the same, while Falco Financial Planning Certified Financial Planner Matthew Bird highlights a ‘UK vanilla tracker’ such as Vanguard FTSE UK All Share Index (GB00B3X7QG63) as a defensive game. He notes that higher commodity prices would bolster oil and mining stocks, while insurance companies such as Legal & General (LGEN) appear to be ‘relatively good value’, and stocks suffering from ESG-related leakage such as British American Tobacco (BATS) look tough enough. The tracker would capture all of this at low cost.
While some analysts view the value investing style as a good hedge against inflation, the emphasis on pricing power has led some scholars to choose quality growth pillars. Bird notes that many farms in the Lindsell Train Global Equity Fund (IE00B644PG05) “Have struggled with Covid-related issues but ultimately have strong pricing power and are expected to withstand inflationary pressures relatively well.” He also notes Fundsmith Equity (GB00B41YBW71) for the strong pricing power of its holdings.
Real assets are still viewed as an effective defense against inflation, as contracts and valuations can adjust to higher prices. The options, however, are plentiful, with investors having to choose between a range of asset classes as well as other decisions such as to support a physical asset or a related stock.
When it comes to physical infrastructure, funds such as HICL infrastructure (HICL) boast a good correlation between their returns and inflation, while renewable energy infrastructure trusts tend to either offer an inflation link to their dividends or aim for a rising payout. But there is an ongoing problem here in terms of valuation, not least the large premiums on the stock price that these trusts tend to charge.
There are ways around this. Alex Brandreth, chief investment officer at Luna Investment Management, instead focuses on sector stocks using the M&G Global Infrastructure Fund (GB00BF00R928).
The premiums on net asset value (NAV) that most infrastructure trusts currently trade on contrast them with other perceived inflation games: stocks of commodity trusts have recently traded at low prices. inexpensive levels compared to their history. Actions in BlackRock World Mining (BRWM) was trading at a 4.2 percent discount to net asset value on December 13, compared to an average premium of 0.5 percent over the previous 12 months. The trust struggled in terms of net asset value and six-month share price performance, having previously had a run.
Commodities funds have had a mixed year and one metal in particular struggled in 2021. The price of gold is far from its August 2020 high, and some are questioning its credentials in an inflationary environment. While it has performed well in several historical inflationary scenarios, the metal may perform poorly if the US dollar strengthens or bond yields rise. Both have happened this year, and a combination of monetary tightening and inflationary pressures could push bond yields and the dollar higher again.
Property has its own appeal as an inflation game. Brandreth promotes TR Property Investment Trust (TRY) for its well-diversified portfolio of real estate assets. It is a very European-centric portfolio with a primary focus on buying shares of real estate companies rather than physical assets.
Physical ownership may come without the risk of equity, but some sub-sectors have behaved very differently from each other during the pandemic. If logistics play like Tritax Big Box Reit (BBOX) trade on high stock price premiums to net asset value after a good run, office and retail focused names such as BMO Commercial Property (BCPT) rallied strongly this year, but now face a new phase of uncertainty if further Covid-related restrictions arise. Perhaps that explains why they trade with double-digit discounts.
Investors who do not wish to refine their exposures could simply opt for a fund dedicated to real assets. Names like Real Assets of Russell Investments (GB00B4KQS127) and Liontrust MA Diversified Real Assets (GB00BRKD9W23) investing in different parts of the real estate space and infrastructure, as well as using other assets such as commodities. A recently launched offer, Elston Liquid Real Assets Index (GB00BLB58C88), combines “higher risk / higher return real assets like commodities and natural resources with lower risk / lower return assets like floating rate bonds”, with the aim of hedging against inflation while posting volatility similar to that of a British gilt.
Finally, it should not be forgotten that capital preservation trusts such as Ruffer Investment Company (RICA) and Personal Wealth Trust (PNL) use a combination of gold, index-linked bonds and stocks as part of an inflation-driven mindset.