The shares Nick Train is backing to shield against inflation

The star investor explains how his fund is protected against increases in the cost of living.

Whether it proves to transitory or becomes more sustained inflation is the number one non-Covid concern among fund managers.

All eyes will be this week be on the August inflation readings for the US and UK. US inflation clocked 5.4% in both June and July, a 13-year high, while UK inflation stood at 2% in July on the consumer prices index measure. The Bank of England, however, expects inflation to rise in the coming months having forecasted an inflation rate of 4% by the end of the year. It then expects inflation to next year cool back down towards its 2% target.

Both the Federal Reserve and Bank of England expect the jump in inflation to be a temporary phenomenon due to bottlenecks in supply chains in certain sectors, which is driving up inflation, along with the unleashing of pent-up demand following the easing of lockdown restrictions.

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In short, various industries that were hit hard by the pandemic are now under pressure to scale production back up to pre-Covid levels. The idea is that once capacity catches up with demand and all the Covid-induced gluts in the supply chain are worked out, inflation rates will fall.

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Some investors, including the fund managers of the Ruffer Investment Company (LSE:RICA), fear high levels of inflation are here to stay in order to do the heavy lifting to reduce the huge government borrowing that has taken place in response to the Covid-19 pandemic.

Nick Train, fund manager of LF Lindsell Train UK Equity, a member of interactive investor’s Super 60 list, admits he “doesn’t know” if inflation will be more permanent than central bankers are forecasting.

He notes in both July and August there was a spike in commodity and logistics costs. Train points out: “This spike could be the result of temporary Covid-disruption; or perhaps the monetary experiment of the last decade is at last feeding through into inflation. We don’t know. In the short term all our consumer stocks fell in August, most of them highlighting increased costs. Fever-Tree and Heineken were hardest hit, off 7% and 5%. Unilever’s drab year continued with a 2% drop.”

Train adds: “Longer term, whatever the outcome on inflation, we are sure it is critical for our investments in companies that produce ‘real’ stuff, as opposed to digital services – to be producing products customers actually aspire to consume or really can’t do without.”

Pricing power, therefore, is a key ingredient to combat rising levels of inflation. On this front, Train has been increasing exposure to pricing power in the fund by adding to its position in Fever-Tree (LSE:FEVR), which he first invested in last February.

“We want more luxury, more premium, more pricing power in the portfolio. This is why we will continue to build the holding in Fever-Tree,” said Train.

“It is also why Diageo (LSE:DGE) is so important for the fund – currently the second largest holding, just behind RELX (LSE:REL). With each passing year more of Diaego’s growth and value is accounted for by its super-premium and premium brands.”

Burberry (LSE:BRBY) and Rémy Cointreau (EURONEXT:RCO), the French spirits company, are two other examples of luxury goods companies that have the ability to “protect shareholders against the effects of inflation”, Train added.

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Other fund managers have been targeting shares that possess pricing power to protect against rising levels of inflation.

Appearing on interactive investor’s Funds Fan podcast in May, Anthony Cross, fund manager of Liontrust Special Situations, one of interactive investor’s Super 60 choices, picked out engineering companies as having “strong intellectual property” and “pricing power”.

Cross picked out engineering companies as having “strong intellectual property” and “pricing power”. The fund owns Spirax Sarco (LSE:SPX), Spectris (LSE:SXS) and Renishaw (LSE:RSW).

Diageo (LSE:DGE) and Unilever (LSE:ULVR) were also named by Cross as other inflation hedges. He points out that both “have decades of experience in being able to adjust prices in line with inflation”.

Job Curtis, fund manager of the City of London (LSE:CTY) investment trust, which is also in interactive investor’s Super 60 list, pointed out supermarkets should be able to pass on food and essential goods' inflation to customers with price increases. City of London has positions in Tesco (LSE:TSCO) and WM Morrison (LSE:MRW).