For the first time in more than a year, professional investors do not consider the Coronavirus to be the biggest risk to global markets.
According to the latest Bank of America survey of fund managers*, COVID-19 has slipped to third place on their list of worries. Instead, the prospect of higher inflation and what this means for financial markets has become the key concern for investors.
So as the end of the tax year draws near, do investors need to consider inflation-proofing their ISA portfolios?
Inflation hasn’t really been an issue for one or two generations in the UK, having peaked in 1979. Even after the global financial crisis, when central banks started their loose monetary policy, inflation stayed low – because it was followed by fiscal austerity.
But with unprecedented levels of combined monetary and fiscal stimulus from governments and central banks around the world today, and the likelihood of a strong economic rebound as COVID lockdown measures are withdrawn, inflation could well rise from here.
According to M&G Investments, on a longer-term view, the need to tackle the huge levels of government debt may also incentivise central banks to allow inflation to run slightly hot before they think about raising interest rates.
M&G also believes that the powerful forces that have kept inflation low for the past few decades - such as globalisation, ageing populations and technology - are unlikely to reverse overnight.
The potential long-term economic damage caused by the pandemic could also have a deflationary impact. “It is far from certain that unemployed and furloughed workers will walk straight back into their jobs, while certain sectors like high street retail may never fully recover,” the fixed income team said. “Meanwhile, if the shift to working more from home becomes permanent, we could see significant downward pressure on city centre rental markets.”
With both inflationary and deflationary forces to consider, it is anyone’s guess as to which direction inflation will head in the long term, but clearly people are worried. Therefore it may be prudent for investors to include at least some inflation-linked protection within a well-balanced portfolio.
Up to 70% of investment assets owned by listed infrastructure companies have an effective means of passing through the impact of inflation to customers**, making this sector a good way to add some inflation-proofing to a portfolio. The added benefit today is that governments around the world have also committed to ‘building back better’, so projects in this sector are also likely to increase.
M&G Global Listed Infrastructure fund looks for a balance of growth and income from three key areas of the sector: economic, social and ‘evolving’ infrastructure. This means investments can include anything from utilities and toll roads to health, education and civil buildings, as well as mobile towers, data centres, payment companies and royalties.
Commodity prices typically rise when inflation is accelerating, so this asset class can offer some inflation protection as well. Gold, for example, has monetary backing, while silver also has a store of value and is further boosted by its industrial use. Other industrial metals like cobalt, copper and lithium are all huge drivers of production and are particularly attractive given the current infrastructure drive and global plans to tackle climate change.
The manager of Ninety One Global Gold worked in the metals and mining sector before becoming a fund manager. It is a concentrated fund investing predominantly in gold mining companies, but also has the ability to invest around one third of the portfolio in non-gold metals such as platinum, palladium, nickel or silver.
Low and rising inflation is good for equities but anything above 3% can be damaging, so it pays to think about the type of equities you are invested in in an inflationary environment. Companies that have the ability to pass price increases onto customers are one example, while cyclical stocks – those that benefit from an improving economic environment – are another.
Artemis Income has been a stalwart of the UK equity income sector for two decades. All the investments in the fund have further similarities: they all have a strong franchise and often a unique product and they all have a quality management team whom the managers have met on several occasions. It currently has more than two-thirds of the portfolio invested in financial and consumer-led companies***.
While inflation is generally bad for bonds, the higher income paid by high yield bonds, coupled with the fact the companies that issue these bonds in tend to do better in an improving economic environment, can mean that this part of the fixed income asset class is less impacted by rising prices.
Baillie Gifford High Yield Bond offers investors access to a portfolio of predominantly UK, US and European high yield bonds. Ideas will come from a variety of sources but will have the key feature of resilience whether from the company’s competitive position, financial structure or its management team. It has a current distribution yield of 4.2%***.
*Bank of America monthly survey, conducted among market professionals managing £430bn worth of money, March 2021
**First State Insights: Infrastructure as a hedge to inflation – May 2018
***Source: fund fact sheet, 28 February 2021
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.