Retail investors move to protect against rising inflation

Inflation-proofing is becoming more widespread among fund investors. We explain why. 

Investor confidence remains high, but inflation is becoming an increasing concern, the latest fund sales statistics from the Investment Association (IA) show.

In the first half of 2021, fund sales hit a four-year high, with total net sales of £24 billion.

Chris Cummings, chief executive of the IA, says that this is a “clear sign of the strong economic recovery and growing investor confidence as we emerge from the pandemic”.

Cummings added: “If the pace of net sales continues at the same rate, we could be on track to match the record-breaking inflows of 2017.”

In June, global funds continued to prove popular, with £1.1 billion invested. Mixed Investment 40-85% Shares and Volatility Managed were the second and third most-popular sectors, with sales of £910 million and £363 million.

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Another trend is that investors are increasingly focusing on adding inflation protection to portfolios. The IA’s recently launched Global Inflation Linked Bonds sector was the highest-selling bond sector in June, attracting £214 million. In total, £5.6 billion is held in the sector. It was the fourth most-popular sector with investors in June, followed by Europe Excluding UK, which attracted £212 million.

Last week, the Bank of England kept interest rates at 0.1%, despite confirming that inflation is expected to climb to 4%, a level which is double its target.

The Bank’s view is that the current inflation pressures are temporary and that inflation will return to 2% in around two years’ time. The Bank’s monetary policy committee (MPC) have attributed the surge in fuel prices and imported goods to the impact of the pandemic as the economy recovers.

In its latest monetary policy report, the Bank said the post-pandemic recovery has “led to higher energy and goods prices, which in turn reflect rising commodity prices, transportation bottlenecks, constraints on production and strong global demand for goods.

“As such, above-target inflation is expected to be transitory, as commodity prices stabilise, supply shortages ease and global demand rebalances.”

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But some investors disagree, and fear inflation will remain high to do the heavy lifting to reduce huge government borrowing in response to the pandemic.

The risk is that inflation becomes structural and hard to control, forcing an earlier than expected rise in interest rates.

How to beat rising inflation

One of the biggest risks for long-term savers and investors is the stealth tax that is inflation, which slowly but surely erodes the real value of money over time. For the past decade, inflation has been pretty much at the bottom of an investor’s worry list. Therefore, inflation-proofing a portfolio may have become a forgotten skill for many.

Rising levels of inflation are bad news for certain parts of the equity market, most notably companies that are price-takers rather than price-makers. Cyclical businesses that compete on price, such as retailers, are negatively impacted. Therefore, it makes sense to target shares that possess pricing power. Recently, we published a piece examining share ideas fund managers are backing to beat inflation.  

Inflation is a bond’s worst enemy, as it erodes the purchasing power of the income that investors are paid. When inflation rises, holders of long-dated bonds suffer the most.

Index-linked bond funds and short-duration bond funds are more resilient than others in the face of rising prices. Three multi-asset investment trusts, which are positioning for higher inflation and have meaningful exposure to index-linked bonds, include Capital Gearing (LSE:CGT), one of interactive investor’s Super 60 choices, Personal Assets (LSE:PNL) and Ruffer Investment Company (LSE:RICA).

Investing in infrastructure, real estate and other ‘real assets’, such as gold, can also be effective ways to shield against inflation.