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Fund picks to protect against rising inflation

Paloma Kubiak
Written By:
Paloma Kubiak

With inflation reaching a two-and-a-half-year high of 1.8% in January, investors may be concerned about its corroding effects on their assets. Here’s how they can protect their portfolio from rising inflation.

The latest inflation figure is important because although it is still below the Bank of England’s target of 2%, it is rising fast and could easily exceed that level in the near future.

The weak pound has made it more expensive to buy goods from abroad and at least some of these extra input costs are being passed on to consumers.

The problem for investors is that inflation can eat into their investment returns and thereby erode the real value of their assets.

So where should investors turn?

Equities vs bonds

Equities’ relationship with inflation is all a matter of degree – a little inflation can be good but lots of inflation is bad, at least if history is any guide.

If inflation does take hold but does not zoom off to the double-digit levels of the 1970s then it would seem reasonable to expect stocks to outperform bonds, especially as the skinny yields currently offered by vanilla sovereign bonds in particular would be swiftly eroded in real terms by the surge in prices.

Index-linked or floating-rate bonds would, however, be a potential bolt-hole and there are some funds which specialise in these areas.

Fund picks:

  • M&G Index-Linked Bond, managed by Ben Lord
  • M&G Global Floating Rate High Yield, managed by James Tomlins

Look for dividend growth

On the stock front, companies that are able to consistently grow their dividend payments can also provide a natural buffer against rising inflation.

Fund pick:

  • Artemis Income

A high quality equity income fund such as Artemis Income is a good choice here. This fund has been one of the most consistent funds in the equity income sector over the past decade with experienced fund manager Adrian Frost expertly navigating almost everything markets have thrown at him over this period.

The fund is well diversified and looks to produce a rising income ensuring that it focuses on companies that offer dividend growth rather than just an outright high yield which helps offset the impact of rising inflation.

That said the current yield of 4.2% looks attractive with the manager finding opportunities in larger UK companies such as BP (BP) and GlaxoSmithKline (GSK). Over the years, the manager has also shown skill in finding opportunities in mid and small companies and occasionally looks overseas should attractive opportunities become apparent.

Quality rises to the top

In the long-term, the best response to inflation is to target companies which have pricing power.

If a firm can charge what it wants to charge it should generate high margins, consistent earnings and robust cash flow, which it can then turn into the reliable and growing dividends which provide such a large percentage of long-term total shareholder returns, especially once they are reinvested.

By contrast, firms without pricing power – such as producers of commodities like paper, pulp or steel – tend to churn out more volatile earnings and more volatile dividends. As a result, their stocks also tend to enjoy lower long-term trend valuations than those firms with pricing power and the ability to provide consistent returns.

Firms with pricing power are the type sought by those funds whose style could perhaps best be described as “quality growth” – they could underperform short term but in the long run class could still tell as they target steady long-term returns via both capital growth and income.

Fund pick:

  • Fundsmith Equity

Fundsmith Equity puts corporate quality at the heart of its strategy. Managed by Terry Smith, the fund has a concentrated portfolio with strict investment criteria which should help investors beat inflation. It has delivered over 150% return over five years, twice the level from the Global sector.

Top holdings include technology giant Microsoft and tobacco titan Philip Morris International.

Ryan Hughes is head of fund selection at AJ Bell