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Inflation protection: eight wealth managers reveal their strategies

UK inflation expectations are rocketing on the slide in sterling following the Brexit vote. We ask eight wealth managers how they are preparing.

Inflation is back

After years of low inflation in the wake of the credit crunch the cost of living is on the rise.

A quarterly report from Barclays said UK inflation expectations have risen at their sharpest pace in more than five years, with the public now believing inflation could be as high as 2.2% in year's time. The Brexit vote in June and the subsequent fall in in sterling, is the major factor behind this spike on these shores. Meanwhile over in the US, Donald Trump's surprise victory in the US election has spooked bond markets with fears of 'Trumpflation'.

Over the longer term, Ruffer fund manager Steve Russell suggested in a recent interview with Wealth Manager UK inflation could be as high as 10% in five years time.

Should this materialise, it would present a real dilemma for asset allocators. We ask eight wealth managers what protection they are building into portfolios.

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Inflation is back

After years of low inflation in the wake of the credit crunch the cost of living is on the rise.

A quarterly report from Barclays said UK inflation expectations have risen at their sharpest pace in more than five years, with the public now believing inflation could be as high as 2.2% in year's time. The Brexit vote in June and the subsequent fall in in sterling, is the major factor behind this spike on these shores. Meanwhile over in the US, Donald Trump's surprise victory in the US election has spooked bond markets with fears of 'Trumpflation'.

Over the longer term, Ruffer fund manager Steve Russell suggested in a recent interview with Wealth Manager UK inflation could be as high as 10% in five years time.

Should this materialise, it would present a real dilemma for asset allocators. We ask eight wealth managers what protection they are building into portfolios.

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Joe Dyer, Alpha Portfolio Management, head of portfolio management, Bristol

Globally, underlying inflationary pressures are building. The UK position is amplified by the material decline in sterling following the EU Referendum. With some forecasting inflation hitting 4% next year, achieving real returns will likely be a major challenge. A further consideration post the election of Donald Trump is global trade, and should this herald a move towards protectionism, then it may exacerbate things further.

Central bank intervention, combined with limited supply, mean it’s very difficult to find value in traditional lower risk areas such as indexed linked gilts. Consequently where appropriate, we would advocate a diversified, equity orientated investment approach and would be alert to investment opportunities that offer an element of inflation protection, in alternative strategies such as infrastructure.

One such example is Civitas Social Housing, which offers investors exposure to quasi-government backed, inflation linked cashflows. This investment is not without risk, not least given the immaturity of the approach, nevertheless we anticipate that their imminent IPO will be well received.

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Thomas Watts, investment analyst, Cumberland Place, London

If inflation will be as rampant in 2017 as we are we led to believe, then an asset whose returns are linked to inflation should act as a natural hedge in such an environment.

A fund that invests in Ground Rents, incorporating regular rent reviews, the majority of which are linked to RPI, could act as an efficient hedge towards inflation. Although property as an asset class has lost some of its shine since the EU referendum.

Ground Rents can act as an alternative to what can be a potentially unpredictable sector. However, offering inflation mitigation is just one facet of the investment. Ground Rents also typically exhibit low correlations to other major asset classes, therefore providing strong diversification within multi-asset portfolios, while the return profile has been very robust, driven by a secure and stable income stream with incremental capital appreciation.

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Kasim Zafar, portfolio manager, EQ Investors, London

Ask about inflation and most people immediately default to talking about gold and TIPS. To my mind, these are equally right and equally wrong! The cause of ambiguity is due to different assets serving their inflation beating characteristics in different market environments.

For inflation scares, such as those around Brexit with the precipitous fall in sterling, holding inflation linkers or gold would have served extraordinarily well. For longer term, low level structural inflation, equities can be a better solution.

In the current environment in the UK, I think we’re past the scary point of currency related inflation, so linkers trading on break-evens of 3% to 3.5% over all maturities seems expensive.

In the US the cause of inflation is one of full economic capacity. This is now combined with the election of Donald Trump that could see degrees of deregulation and fiscal expansion. Here, I think US equities may well beat inflation handsomely.

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Dean Whitty, investment manager, Ramsay Crookall, Isle of Man

One of the traditional ways of protecting against rising prices is to invest in equities as companies can increase their prices to compensate but not all sectors will perform well. Financial stocks, particularly banks, have been deeply out of favour due to increased regulation and low interest rates negatively affecting margins.

However, a rise in interest rates and bond yields would be very beneficial to their profitability and on this basis we have been selectively purchasing the Polar Capital Financials Trust. The trust has over 50% of its underlying positions in in banking stocks and provides exposure to both US and European financials. It trades on a double-digit discount to NAV, low gearing at around 7% and currently yields over 3%.

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Ben Conway, senior fund manager, Hawksmoor Fund Managers, Exeter

The best way to beat inflation is to invest in an asset that generates a current income yield above the prevailing rate of inflation with explicit inflation linkage while taking on as little credit risk as practically possible. Inflation-linked gilts, which carry minimal credit risk, are currently priced to guarantee a negative real return regardless of the future rate of inflation.

We must be more creative and explore the investment trust universe. These funds do carry some credit risk, but we’d suggest holding a basket of them. Target Healthcare Reit yields 5.5% with all the income (derived from ownership of well-run, high quality nursing homes) explicitly linked to inflation. One would hope nursing home fees would be among the last bills to be cut when times get tough. Other property investment trusts have targeted exposure with high yields and shorter-term leases which offer scope for rental uplift as inflation takes hold. AEW UK Reit is one such example.

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Nathan Sweeney, senior investment manager, Architas, London

One of the main ways we try to beat inflation is using alternatives, in particular real assets. If you invest in a school or a hospital project and you have a contract with a local authority or government then the typical contract has a fixed cash flow that adjusts each year in line with RPI and CPI.

This gives a very clear mechanism of how cash flows will increase in an inflationary environment. You can be confident as long as the UK government doesn’t do the dirty on you, cash flows are going to increase in line with inflation. One fund we currently hold in this area is the John Laing Infrastructure fund.

We also expect Donald Trump’s commitment to infrastructure investment to be the first move in a global wave of developed market commitment to infrastructure spending. This is likely to give the sector a further boost.

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Caspar Rock, chief investment officer, Cazenove, London

Ground rents as an asset class can provide an attractive level of income, whilst at the same time providing at the very least a partial (albeit lagged) hedge against inflation. A ground rent is the income that a freeholder of a property receives from their leaseholders. Ground rents are typically linked to RPI, CPI or some formulaic increase over time, although with a lag as the reset for a ground rent may happen every 5,10 or 20 years.

One way to access this asset class is through the Ground Rents Income Fund, an investment trust. This fund trades at a small premium to the most recently published NAV, yields approximately 3% and has a proven record of growing its dividend. Because of the long-dated nature of the ground rent contracts, it has little sensitivity to the value of the underlying property.

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Philip Greenman, branch manager Exeter, Charles Stanley

For direct and low cost inflation protection on client portfolios we have been buying the iShares $ TIPS ETF. This ETF offers exposure to US Treasury Inflation Linked Government Bonds with a weighted average maturity of 9.2 years and an effective duration of 8.3 years.

Expectations for inflation in the US economy have been building but have increased in the very short term as Donald Trump’s policies are expected to be reflationary and the probability of an interest rate rise in December has reduced.

TIPS do not look ‘cheap’ and there is an element of currency risk with this holding but we see the overall drivers as compelling and the holding offers diversification from our other bond exposure such as UK inflation linked gilts and credit funds. The fund has an TER of 0.25%.

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