14 investment trusts to inflation-proof your portfolio

Higher inflation is on its way, Faith Glasgow considers how investors can protect their portfolio.  

The news this week that consumer price index inflation stood at just 0.4% in February, down from 0.7% in January as clothing prices were cut by retailers, is hardly surprising as lockdown continues.

As Charles Hepworth, investment director at GAM Investments, observes: “Only when we return to a more normalised and open economy can sharply higher inflation surprises manifest, and even then that’s not a given.”

Nonetheless, as a recent note from the investment trust analysts at Peel Hunt makes clear, inflation is likely down the line as economies globally recover from the impact of the pandemic.

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There are several factors lining up to bolster prices, says Peel Hunt. “The global deployment of vaccines is signalling a strong economic recovery in the second half of 2021, with widespread fiscal stimulus and accommodative monetary policy (low rates and quantitative easing).”

In addition, consumers are desperate to get their lives back and start spending in the aftermath of lockdown.

Assuming inflation is on its way, then, what are the best ways for investors to protect their portfolios from rising prices?

Turn to alternatives to protect against inflation

Long-dated bonds are set to be the biggest losers as their fixed-income payouts lose real value. But equities could also be problematic. Not only has their correlation with bonds increased recently, but they have historically reacted poorly to short-term unexpected hikes in inflation.

Peel Hunt therefore focuses on alternative investments. Real assets and property trusts, particularly those with inflation-linked rents or cash flows, are one option – although it notes they could be negatively impacted if interest rates rise and borrowing becomes more expensive.

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Edward Allen, investment director at Tyndall Investment Management, favours infrastructure trusts. “One that I invest in is International Public Partnerships (LSE:INPP), which quotes a 0.78% inflation linkage on its portfolio as a whole (as of June 2020),” he says. That means a 1% rise in inflation will produce a 0.78% increase in returns.

However, he warns: “Investors should be a little wary, as if inflation rises rapidly then it is likely that the discount rates used to value infrastructure trusts will also start to rise, reducing the portfolio value.”

At Numis, the investment trust analyst, Andrew Rees also likes INPP. “The diversified cashflows are underpinned by government counterparties, further strengthening the quality of income, which has a long average life of over 30 years,” he points out. It is worth noting that INPP trades on a 9.3% premium to net asset value.

Watch out for high premiums

Elsewhere, renewable energy trusts offer “consistently high inflation-linkage”, says Peel Hunt, with Foresight Solar (LSE:FSFL) and Greencoat Renewables (LSE:GRP) leading the way. Again, though, both are on double-digit premiums, which may make them too pricey for new investors.

Allen suggests that another, smaller, real asset-focused trust to consider is Tufton Oceanic Assets (LSE:SHIP), which owns a fleet of 21 container ships and rents them to various shipping and merchant companies.

“According to the company, shipping rates have performed well in times of inflation in the past, which makes sense if inflation is caused by a surge of demand for goods,” he comments.

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Among property trusts, Peel Hunt picks out LXI REIT (LSE:LXI), which has 95% of its rental income either index-linked or subject to fixed uplifts.

Peel Hunt also likes Tritax Big Box (LSE:BBOX) and Tritax EuroBox (LSE:BOXE), where again most of the rental income is index-linked, and the two care home specialists Target Healthcare REIT (LSE:THRL) and Impact Healthcare REIT (LSE:IHR), for the same reason. “Recent rent collection statistics [for care home trusts] have been robust,” it adds.

Go for gold as an inflation hedge  

Commodities and gold also offer inflation plays. Baker Steel Resources (LSE:BSRT), BlackRock World Mining (LSE:BRWM) and Scottish Investment Trust (SIT) all have between 22% and 25% of their portfolios allocated to gold equities and physical gold.

For those looking for a more tactical, cyclical resources focus, BRWM also provides good exposure to broader commodities.

“The recent results from the BRWM team point to tightness across commodity markets as a result of underinvestment,” comments Peel Hunt.

“The demand story also looks compelling, particularly in light of the synchronised global infrastructure spend.”

Better still, it adds, “the valuations for mining companies are cheap and there is scope for dividend upside.”

Mixed-asset trusts positioning for higher inflation

In the flexible investment trust arena, those that focus on capital preservation are another good option for inflation hedging.

Rees picks out the highly diversified Capital Gearing (LSE:CGT) as “well-placed to offer protection against rising inflation, with its dual objectives of preserving shareholders’ real wealth while still delivering absolute total return over the medium term”.

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Ruffer (LSE:RICA), meanwhile, combines holdings in cyclical recovery stocks with inflation-protected securities, gold and bitcoin. “The inclusion of swap options provides effective hedging against future interest rate rises,” Peel Hunt adds.

So there are choices available if you’re concerned about the risk of inflation, but look carefully at the share price discount/premium to net asset value (NAV) before you commit yourself.