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Fund Selector: Upside of deflation

Fund Selector: Upside of deflation

Along with many other investors, my colleagues and I have recently been discussing the impact of falling inflation and its implications.

There are undoubtedly some short-term beneficiaries: it improves the purchasing power of UK consumers and provides a timely boost to David Cameron’s prospects ahead of the UK general election.

At the risk of stating the obvious, the main drivers of deflationary pressure have been the oil price collapse and food price deflation, although inflation was already trending downwards prior to the fall in oil prices.

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However, it is often forgotten that as time passes inflation naturally resets. As a consequence, unless this deflation is structural, which I don’t believe it is, then an inflationary environment will return next year.

There is great speculation about the oil price fall and the extent to which political motivations have driven the behaviour of those involved. It is clear, however, that the Organisation of the Petroleum Exporting Countries, known as Opec, and, more specifically, Saudi Arabia, did not cut production to support the oil price.

Their exact motives are unknown but it seems likely the impact of US shale producers and the ever-increasing numbers of marginal oil players were significant factors in Opec’s decision making.

Ultimately, the most pertinent question is whether it is possible for one to exploit the effects of seesawing oil prices and inflation.

Unfortunately, one cannot replicate or go out and buy a unit of inflation, although Hermes is trying to do just that with a novel approach via their recently launched multi-asset inflation fund.

On the other hand, access to oil-related investments is far more possible and there are two traditional ways of achieving this: oil-related equities and the futures market through a specialist fund.

Within the equity route, there are a number of specialist managers but one takes on a high degree of sector-specific risk, which could help reflect a strong view in client portfolios.

I opt for a safer route with equities and expect our regional generalist managers to take a view on the sector.

With respect to futures, unsurprisingly, recent performance has been rather dreadful but one should be looking forward (excuse the pun) not backwards on this call.

I am currently conducting some research on futures managers but have to grapple with performance expectations as energy, while being an important sector, is still only a portion within an index that also has exposure to metals – precious and base – and soft commodities.

I also have to ask myself – can I accept the volatility?

James Calder is research director at City Asset Management