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Choosing the best inflation-busting investment strategies

Choosing the best inflation-busting investment strategies

Investors have been keeping a close eye on UK inflation since it peaked at 2.9 per cent in May. 

Tthe Consumer Price Index (CPI) measure of price growth has since levelled off at 2.6 per cent in June and July. But there are many who continue to think that it could hit 3 per cent by the end of 2017.

The rises may have come as a surprise to investors who had grown used to several years of subdued prices. While it is not at the 5 per cent level briefly touched in 2012, CPI inflation has now been above the Bank of England’s 2 per cent target for six months. 

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With investment returns harder to come by now than they were five years ago, the challenge of how to beat price rises remains a tricky one, not least because many of the instruments are an imperfect match. 

Typically, asset classes such as equities, commodities and gold have been used by advisers and their clients to protect against rising inflation, in addition to perhaps the most obvious defence: inflation-linked bonds.

But these are not proving as effective as they have been in the past. 

As Will McIntosh-Whyte, assistant fund manager at Rathbones, points out, inflation-linked bonds – like most government bonds – are expensive. 

“Added to that, buying these assets means you take on even more duration, or sensitivity to interest rates, than their conventional gilt counterparts due to the lower coupons on offer,” Mr McIntosh-Whyte explains.

“At the moment, you would need inflation to average 3 per cent each year for the next 10 years to outperform plain-vanilla gilts, which are negative in real terms anyway because inflation outstrips the yield they offer. 

“You would be taking on a substantial amount of interest rate risk to gain this protection, and if you were right, chances are that the Bank of England would be raising rates to dampen inflation, so the loss would hurt you potentially more than you stand to gain.”

Indeed, UK inflation-linked bonds have posted negative returns since the end of October 2016, despite CPI inflation rising from 1 per cent to its current level since then.

George Efstathopoulos, multi-asset portfolio manager at Fidelity International, suggests that more complicated techniques must be employed to safeguard portfolios without being exposed to interest rate risk.

“One way to mitigate the duration impact is to invest in inflation breakeven instruments – an area we have recently witnessed with the launch of exchange-traded funds (ETFs). 

“While ETFs aim to provide a better outcome for investors wishing to hedge against rising inflation, we should note that they require additional due diligence due to the use of more complex derivatives.”

Metals and miners

Gold is generally considered to be a flight to safety in times of uncertainty, with investors piling into the precious metal once again when tensions between North Korea and the US rose in August.