Consumers have tangible evidence of the impact of price rises in their weekly shopping and domestic bills. Little wonder, then, that inflation is a key concern.
As the manager of two cautious multi-asset fund of funds portfolios – which are used by many investors as one-stop investment solutions – I’m often asked by advisers how we address the inflation threat.
Inflation can present itself in a multitude of forms. High street inflation is the most obvious, though at present it is difficult to see this becoming entrenched, which can happen through mechanisms such as “wage-price spirals”. (With labour markets and growth prospects so weak, employees are reluctant to press wage demands – though a hint of such conditions might actually be welcomed by Western central banks preoccupied with policy measures to generate economic growth and improve employment conditions.)
The most pernicious form of inflation is monetary inflation. It is worth remembering the adage that “inflation is always and everywhere a monetary phenomenon”. We know that in a time of debt de-leveraging policymakers will welcome moderate levels of monetary inflation to see their paper currencies – and consequently real debt levels – gradually devalue.
It is possible to deliver a degree of protection from this form of inflation, which has more of a direct bearing on asset prices. Indeed, it can also create opportunities.
It leads us to prefer real assets (i.e. those that have intrinsic value) over nominal assets (i.e. those whose value is by reference to paper currencies).
So, in our case, that means being overweight equities (within our more defensive portfolio, where the strategic allocation to equities is 25%, we are currently holding 32%, having taken advantage of the recent correction to increase exposure). Within this we have introduced a bias to overseas assets, particularly in the Asia and Emerging Market regions, which we believe have stronger growth prospects and are not challenged by the same debt burdens and de-leveraging issues facing most Western, developed markets. We anticipate gains will also come from the appreciation of their currencies relative to Sterling – a classic example of looking to exploit opportunities from the inflation story.
Other real assets include commodities – we hold just under half our 10% commodity exposure in the T. Bailey Defensive Cautious Managed Fund in Gold, through a physically backed ETF, while the rest is in the equity of commodity producers (the latter offer the prospect of income as well as growth and inflation protection).
We are currently underweight fixed income assets– in part a reflection of the impact that monetary inflation can have on these nominal assets.
That said, within the fixed income part of a portfolio it is still possible to outpace inflation and managers can add real value through strong performance. Strategic and high yield bond funds, which place more emphasis on generating returns through use of corporate credit markets can generate respectable yields, in excess of current year-on-year CPI and RPI. Global sovereign debt managers have opportunity to profit by tactically allocating between countries, currencies and the duration of bonds held; and use of index-linked funds can also build in inflation protection through linkage to RPI.
In short, it is possible to protect against inflation. It’s even possible to take advantage of it. We try to do both.
Submitted by: Elliot Farley
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