The consumer price index (CPI) – the UK’s measure of inflation – rose to 1% in September, driven by increases in fuel and clothing prices combined with sterling weakness. The Bank of England’s (BoE) latest inflation report forecasts CPI rising to 2.7% by the end of 2017.
While rising inflation can be a positive, it can also threaten the value of your investments if they don’t keep pace with it. And with interest rates at all time low levels this is particularly the case for cash.
That said, it does make sense for investors to have at least some allocation to cash within their portfolios. Read more about the role of cash in a portfolio in our Autumn Investment Outlook.
UK Real Interest Rate since 1989
Source: Bloomberg
The chart above shows the UK’s Real Interest Rate (the interest rate minus the inflation rate) is currently in negative territory. It is not a certainty that inflation will rise significantly from here, but if it is coming back how can you protect your portfolio against it? We have identified a number of funds and ETFs with potentially inflation-proof attributes.
Income funds
Companies with high barriers to entry and pricing power can offer some protection against inflation. Those paying dividends provide a further return, whether you choose to take the income or reinvest it. For global equities, take a look at Artemis Global Income. If you want to access just UK companies, Threadneedle UK Equity Income could fit the bill.
Index-linked Bonds
While inflation is the enemy of bond markets, index-linked bonds, as the name suggests, are linked to inflation in order to protect the value of investments. L&G All Stocks Index Linked Gilt Index provides exposure to the UK index-linked market, although this fund has performed strongly of late and may start to look expensive if interest rates rise. For an exchange traded fund option which holds global index links please see below.
Alternatives
Infrastructure assets such as toll roads typically have their prices linked to inflation. First State Global Listed Infrastructure is on our Recommended Funds list.
Gold can be used as a hedge in uncertain markets and can offer an inflation insurance policy. Take a look at BlackRock Gold & General.
Rising property prices, combined with rental yield, have also offered an effective hedge against inflation in the past. L&G UK Property Feeder offers exposure to the UK commercial property market.
Commodities is another asset class which is worth considering. Inflation can be closely correlated to the price of oil and other commodities. First State Global Resources invests across a range of commodity holdings.
Exchange traded funds
Another way of gaining low-cost access to these asset classes is via exchange traded funds (ETFs). Here are some you may want to investigate further:
Global index-linked bonds – iShares Global Inflation Linked Government Bond
Gold – ETFS Physical Gold
Commodities – Lyxor Commodities TR/Core Commodity CRB
Areas to avoid
In an environment when interest rates are lower than inflation, cash does not provide any protection. As prices go up the purchasing power of your cash is being eroded – in effect your cash will buy you less.
Bonds also typically don’t protect against inflation. If interest rates or inflation go up, the yield on a bond doesn’t go up with them as it is fixed at the time of issue.
Key considerations
There are two key things to consider when trying to insure your portfolio against inflation. First, asset classes intended for inflation protection should be genuine inflation hedges. We’ve given you some ideas of asset classes and funds you could use. Second, it is not only important to consider whether a particular asset class is inflation proof, but also the correlation of asset classes to each other. As ever, it is essential for long-term investors to have a balanced, well diversified portfolio whatever the economic backdrop.
The table below shows how each of the asset classes has performed relative to UK inflation over the last 20 years (where data goes back that far).
| Asset Class | Number of years analysed | Frequency of outperformance of UK CPI | Outperformance % | Annualised return, % |
| Global Equities | 20 | 15 | 75 | 6.28 |
| UK Equities | 20 | 14 | 70 | 6.72 |
| Global Bonds | 20 | 13 | 65 | 4.81 |
| UK Gilts | 20 | 15 | 75 | 6.35 |
| Global Index Linked Bonds | 19 | 15 | 79 | 6.65 |
| UK Index Linked Bonds | 18 | 14 | 78 | 7.10 |
| UK Property | 20 | 16 | 80 | 9.23 |
| Infrastructure | 17 | 9 | 53 | 2.51 |
| Commodities | 20 | 11 | 55 | 3.53 |
| Gold | 20 | 13 | 65 | 5.46 |
| Cash | 20 | 14 | 70 | 3.82 |
Past performance is not a reliable indicator of future results
Source: Morningstar Direct from 1996 to 2015
Exchange Traded Products (ETPs) including ETFs, ETCs and ETNs track a wide variety of underlying investments, some of which may be complex in nature and involve leverage, shorting or a high degree of volatility. It is therefore important that you read the Prospectus or Fact Sheet (available on the issuers’ websites) prior to investing and ensure that you understand how it is structured and the associated risks.
Remember that each fund is unique and hence exposed to different levels of risk. Some are relatively low risk, whilst others can be very risky and those will only be appropriate for more sophisticated investors.
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