Vantage Point: Volatility  

Investing at a time of higher volatility

  • To discover how different asset classes perform in volatile conditions
  • Understand how residential property performs in inflationary conditions
  • To understand how inflation can cause volatility in markets
Investing at a time of higher volatility
Erickson Balderama via Pexels

Protecting the real value of clients’ savings is clearly a priority for any financial adviser.

This involves seeing through what is sometimes described as the 'veil' of money.

Without advice, a client might be quite happy to earn 1.5 per cent on their cash, but with inflation at 5.5 per cent and set to rise, we know that’s a real-terms loss of approximately 4 per cent - at the very least.

The veil of money idea implies that the nominal value of money not only does not matter but also that it hides the real values of things and the real returns on our investments.

Failing to look through that veil didn’t matter so much when inflation was low. But with inflation now running at 7.9 per cent in the US and 5.5 per cent in the UK, it seems we need to be making that extra mental effort to see things in real terms again. 

Even before Russian tanks rolled into Ukraine, there were all sorts of reasons to think that those higher levels of inflation were not going to go away.

Unfortunately, and tragically, there is now another one. Oil and gas, wheat, soybeans, nickel, you name it – it’s all going through the roof. 

There is even talk of a 1970s' style wage-price spiral, with higher prices feeding into wage demands, and pay rises fuelling higher prices. It may not happen – but it’s a serious possibility. 

Another, connected risk is that rising inflation will cause central banks to raise interest rates to a level where they choke off economic growth.

Given the mood of the moment, however, it seems more likely that inflation will be left to run at a higher level for a while. Charlotte Yonge, manager of Personal Assets Trust, has commented that the Russia-Ukraine war may provide cover for central bankers to be softer on inflation than they might have been otherwise.

All this means the real value of cash balances is being eaten away at a disconcerting rate. But what does it mean for our investments and what defences can we put in place – or is it too late?

First the bad news. Most asset classes do not have a great record of protecting investors from higher levels of inflation.

Crunching numbers 

Let’s start with equities. In the latest Credit Suisse Global Investment Returns Yearbook – which covers 122 years of stock market data across 21 countries – Professors Dimson, Marsh and Staunton divide those years into buckets depending on the rate of inflation in that year. They then look at real equity returns in each of those years.

The data blows away any idea that equities are an inflation hedge. In fact, their real returns are negatively correlated with inflation. 

If you want to look on the bright side, over that long period, equities eked out a positive real return on average even with quite high levels of inflation. It’s only when you come to the top 5 per cent of inflation rates that the real return turns negative, a real-terms 10 per cent loss.