Inflation is set to return in 2017 but much of the increase in prices in the UK is expected to be driven by temporary external factors.
At the same time the Bank of England has stated it is happy to let inflation over shoot its 2 per cent target due to a weaker pound and recovering oil prices without considering raising interest rates.
In terms of what is behind current inflation, transportation costs such as petrol showed the biggest swing in government statistics from being the main driver of lower inflation in November 2015 to the biggest contribution to inflation in November 2016.
Clothing was the biggest cause of inflation over the last 12 months as import costs have been rising.
As a result of mounting fear as UK inflation (CPI) rose to 1.2 per cent in November, up from 0.9 per cent in October, we asked Adrian Lowcock, investment director of Architas, to share his picks for funds to protect against inflation.
Mr Lowcock said: “Many companies in the equity income space offer inflation protection with the ability to raise prices, however the sector has attracted a lot of money from investors looking for income as bond yields fell, driving up valuations in certain areas.
“As this reverses and bond yields begin to rise we could see investors switch from equity income in favour of bonds.”
Infrastructure
His first fund pick focuses on infrastructure.
Infrastructure is likely get a spending boost in the next few years as western governments switch from using monetary policy to fiscal stimulus.
Infrastructure projects are often linked to the retail price index (in the UK) and therefore revenues increase along with inflation.
However, there is a delay and infrastructure assets haven’t risen as much as other inflationary linked investments.
In addition, infrastructure offers some protection for investors should inflation disappoint as it continues to provide a stable and predictable income with low volatility which remains attractive in a low interest rate environment.
Mr Lowcock picked John Laing Infrastructure fund, which invests directly in the equity of a diverse range of PFI projects, as a vehicle that could protect against inflation in 2017.
The fund invests in the concession of the infrastructure projects rather than obtaining full ownership i.e. the asset returns to the government at the end of the concession period.
Mr Lowcock said this is a defensive fund and has a diversified portfolio which pays a predictable, inflation-protected yield. Investors should expect steady, low-risk income with some small potential for capital growth.
Bond yields
The next focus for Mr Lowcock’s second pick is bonds.
Bond yields have already risen in anticipation of rising inflation so investors need to be further afield.
The yield on floating rate notes is linked to Libor (or similar) which increases with rising inflation expectations and interest rates.
Floating rate notes are short dated as the interest paid is updated every three to six months. As such the capital values are less sensitive to rising bond yields.
To make the most of this, Mr Lowcock recommended Neuberger Berman Global Floating Rate Income fund.
The investment process for this fund relies on a combination of bottom-up fundamental bond analysis but includes some global economic analysis.
Individual analysts submit ideas to the team which are then reviewed and approved by the investment committee of the fund.
Mr Lowcock recommended Neuberger Berman’s disciplined approach to investing and large research team that is able to identify opportunities.
Commodities
Commodities, and the close correlation to inflation as rises in commodity prices drive inflation higher, is what has influenced Mr Lowcock’s third fund choice.
Commodity prices have already recovered from the low levels seen at the beginning for 2016 but if western governments embrace fiscal stimulus and commit more money to infrastructure spending then Mr Lowcock said commodities should continue to do well.
Mr Lowcock recommended Investec Enhanced Natural Resources fund, which targets long term capital growth with a relatively low volatility by investing across the entire spectrum of commodities and resource companies.
An unusual feature of this fund, according to Mr Lowcock, is that it can make money from price falls as well as rising prices by using derivatives.
He said these are used mainly to manage risk, reduce volatility or benefit where they have a negative view.
Darius McDermott, managing director of Chelsea Financial Services, said Mr Lowcock picked some nice ideas and agreed infrastructure was a good bet in 2017 plus an area he had liked for some time.
Mr McDermott said advisers may also want to consider the investment trust sector, which was at a very high premium post-Brexit but has come off a little now, which is good.
If you would like an open-ended option, Mr McDermott said he currently likes Legg Mason IF Rare Global Infrastructure, which has a yield target of 5 per cent.
The fund seeks capital appreciation and income by investing in securities issued by companies that are engaged in the infrastructure business, and other investments with similar economic characteristics.
Infrastructure companies may include those engaged in the construction, renovation, ownership, development, financing, management or operation of infrastructure assets or that provide raw materials necessary for the construction and maintenance of infrastructure assets.
When it comes to bonds, Mr McDermott said he liked Axa Sterling Credit Short Duration bond, which only invests in bonds close to maturity and will be less sensitive to inflation and rising interest rates.
And when it comes to commodities, energy companies also tend to do well. While they are heavily regulated, the regulator will allow them to raise prices in line with inflation. So the likes of utilities stocks or even gas companies may be attractive, or a fund like Guinness Global Energy.
emma.hughes@ft.com
