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UK inflation over 3% - what can investors do?

In this week’s inflation print, the UK hit a highpoint. According to the Office for National Statistics, the UK’s CPI rate hit 3% - a level not seen in more than 5 years. And it’s not just the UK – globally inflation has been creeping up.

Inflation is a threat to savers, eroding the spending power of a portfolio. This presents a challenge – how to protect a long run portfolios? There are investment funds which could offer a solution, but this depends on the scenario. Here are three options to protect and perhaps profit from rising prices.

Chart of inflation rates, year on year growth. Historic data (solid line) source: Bloomberg, Office for National Statistics. Past data is no indication of future results. 6 month forecast data (dashed line) source: Société Générale research. The figures relating to future performance are a forecast and are not a reliable indicator of future results.

Find out more about UK and global inflation

Scenario 1: Inflation rises, but rates stay low

This scenario is similar to what we’re seeing presently in the UK. In late 2015, the CPI rate was negative – it has now risen to 3%.

The Bank of England’s rate setting Monetary Policy Committee has one aim – to control inflation. So this latest release puts more pressure on the members to hike rates in response. But this has not so far been the case which means cash savings rates are likely to be below inflation for the meantime.

In these scenarios, a portfolio of inflation linked bonds could be the easiest way for investors to protect themselves. Their interest coupons and their principal values are adjusted with the rate of inflation, creating a direct link. Remember gilt prices move down as well as up; if we hit a period of deflation the interest and principle would fall.

In the UK, index linked gilts are currently benchmarked to the higher RPI rate – currently 3.9% – which is still seen as the benchmark by many pension funds and households. The Lyxor FTSE Actuaries UK Gilts Inflation-Linked (DR) UCITS ETF (GILI) is a physical fund giving access to the whole market of index linked gilts, with ongoing charge just 0.07%.

Scenario 2: Inflation rises and rates are hiked in response

Though UK rates haven’t yet been hiked, the question may be “how long”? There are signs of unrest in many banks. Two of the MPC members have been voting for a rate rise since June.

Interest rates are a challenge for inflation linked bonds. A cocktail of long maturity dates with low yields means the indices typically have high duration. When interest rates do escalate, linker prices are vulnerable.

In this scenario, it could be worth looking at inflation expectations. These are constructed to give exposure to the inflation premium, but are hedged against interest rate changes. Inflation expectations overlays have been used (via derivatives) in many institutional portfolios for years, but only in the last year has the strategy been available through UCITS ETFs. Lyxor offers three inflation expectations ETFs – with charges of 0.25%. The most recent launch, Lyxor UK£ 10Y Inflation Expectations UCITS ETF, is the first and only fund available on the UK’s expected inflation rate.

Scenario 3: Rate hikes lead the inflation rate

The USA is in a different scenario to the UK. Though inflation has been creeping up, American price rises have not hit the two percent goal. Nevertheless interest rates are already rising – the Federal Reserve has forged ahead with several rate hikes already this year.

This scenario could be tough for both conventional and index linked bonds. But floating rate notes could be a solution. These notes fix their coupons to interest rates, thereby raising payments when central banks act. The result is a much more stable return in a rising rate environment. These are not without risk – prices can go down as well as up. These also bear credit risk – issued by corporations not governments, you can lose money if the issuer defaults.

Lyxor recently launched the Lyxor $ Floating Rate Note UCITS ETF (BUOY LN). This is a way to get diversified access to USD floating rate notes – covering 120 notes with charge 0.15%. This is a UCITS fund, eligible for ISAs and SIPPs and has UK reporting status.

To find out more about Lyxor and their range of inflation linked bond investments visit www.LyxorETF.co.uk

Disclaimer

THIS COMMUNICATION IS FOR ELIGIBLE COUNTERPARTIES OR PROFESSIONAL CLIENTS ONLY

All charge and fund data correct as at 17.10.17. Inflation source: Office for National Statistics This document is for the exclusive use of investors acting on their own account and categorized either as “Eligible Counterparties” or “Professional Clients” within the meaning of Markets in Financial Instruments Directive 2004/39/EC. These products comply with the UCITS Directive (2009/65/EC). Société Générale and Lyxor International Asset Management (LIAM) recommend that investors read carefully the “investment risks” section of the product’s documentation (prospectus and KIID). The prospectus and KIID are available free of charge on www.lyxoretf.com, and upon request to client-services-etf@lyxor.com.

The products mentioned are the object of market-making contracts, the purpose of which is to ensure the liquidity of the products on the London Stock Exchange, assuming normal market conditions and normally functioning computer systems. Units of a specific UCITS ETF managed by an asset manager and purchased on the secondary market cannot usually be sold directly back to the asset manager itself. Investors must buy and sell units on a secondary market with the assistance of an intermediary (e.g. a stockbroker) and may incur fees for doing so. In addition, investors may pay more than the current net asset value when buying units and may receive less than the current net asset value when selling them. Updated composition of the product’s investment portfolio is available on www.lyxoretf.com. In addition, the indicative net asset value is published on the Reuters and Bloomberg pages of the product, and might also be mentioned on the websites of the stock exchanges where the product is listed.

Prior to investing in the product, investors should seek independent financial, tax, accounting and legal advice. It is each investor’s responsibility to ascertain that it is authorised to subscribe, or invest into this product. This document is of a commercial nature and not of a regulatory nature. This material is of a commercial nature and not a regulatory nature. This document does not constitute an offer, or an invitation to make an offer, from Société Générale, Lyxor Asset Management (together with its affiliates, Lyxor AM) or any of their respective subsidiaries to purchase or sell the product referred to herein.

Lyxor International Asset Management (LIAM), société par actions simplifiée having its registered office at Tours Société Générale, 17 cours Valmy, 92800 Puteaux (France), 418 862 215 RCS Nanterre, is authorized and regulated by the Autorité des Marchés Financiers (AMF) under the UCITS Directive (2009/65/EU) and the AIFM Directive (2011/31/EU). LIAM is represented in the UK by Lyxor Asset Management UK LLP, which is authorized and regulated by the Financial Conduct Authority in the UK under Registration Number 435658. Société Générale is a French credit institution (bank) authorised by the Autorité de contrôle prudentiel et de résolution (the French Prudential Control Authority).

Lyxor International Asset Management (“LIAM”) or its employees may have or maintain business relationships with companies covered in its research reports. As a result, investors should be aware that LIAM and its employees may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please see appendix at the end of this report for the analyst(s) certification(s), important disclosures and disclaimers. Alternatively, visit our global research disclosure website www.lyxoretf.com/compliance.

CONFLICTS OF INTEREST This research contains the views, opinions and recommendations of Lyxor International Asset Management (“LIAM”) Cross Asset and ETF research analysts and/or strategists. To the extent that this research contains trade ideas based on macro views of economic market conditions or relative value, it may differ from the fundamental Cross Asset and ETF Research opinions and recommendations contained in Cross Asset and ETF Research sector or company research reports and from the views and opinions of other departments of LIAM and its affiliates. Lyxor Cross Asset and ETF research analysts and/or strategists routinely consult with LIAM sales and portfolio management personnel regarding market information including, but not limited to, pricing, spread levels and trading activity of ETFs tracking equity, fixed income and commodity indices. Trading desks may trade, or have traded, as principal on the basis of the research analyst(s) views and reports. Lyxor has mandatory research policies and procedures that are reasonably designed to (i) ensure that purported facts in research reports are based on reliable information and (ii) to prevent improper selective or tiered dissemination of research reports. In addition, research analysts receive compensation based, in part, on the quality and accuracy of their analysis, client feedback, competitive factors and LIAM’s total revenues including revenues from management fees and investment advisory fees and distribution fees.

This article was provided by Lyxor and does not necessarily reflect the views of Citywire

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