Getting returns that beat inflation

A journalist I know recently pointed out that 2021 started off with talk of the ‘Roaring Twenties’ but ended with fears of raging inflation.

It was also a year that began with people feeling relatively flush - if they were among the lucky bunch who had built up lockdown savings - but also ended with many feeling the pinch. And this is a feeling that is unlikely to go away in the first few months of 2022.

UK inflation jumped to 5.1% in November – it’s highest level since September 2011 – and there are more price hikes on the way for the British public. Energy price cap increases in 2022 could push up annual energy bills by a huge £400 in some cases, council tax rates could increase by about 2.8%, according to the Institute for Fiscal Studies, rail fares are due to go up by 3.8% and the new social care tax increases included in our National Insurance payments are due to kick in.

So, what can we do to make ourselves feel richer rather than poorer?

The first place to start is obviously cutting any unnecessary spending if possible and getting better deals on bills or loan payments. And if you do have any savings, investing is going to be better than cash in this environment. It’s a lot more risk, but the rewards are potentially a lot better too.

The best easy access Cash ISA I could find on today (22 December) was 0.6%. If inflation stays at 5% for one year, the spending power of £100 saved in this account reduces to about £95. So, in real terms you would be losing money.

Carl Stick, co-manager of Rathbone Income fund, calls this financial repression. “Many strategists are predicting an extended future of negative real yields, as central banks look to diminish their debt piles,” he said. “Unfortunately for savers - and there are a lot of these in the UK - this heralds ‘financial repression’ - when the return offered to savers lags the corrosive effects of inflation.

The impact of inflation on £100 (for example, if the saving rate is 1% and inflation is 5%, look in the column showing 4%):

Years/inflation 1% 2% 3% 4% 5% 6%
After 1 year £99.00 £98.02 £97.04 £96.07 £95.11 £94.16
After 2 years £98.02 £96.08 £94.17 £92.30 £90.46 £88.67
After 3 years £97.04 £94.17 £91.38 £88.67 £86.04 £83.49

Investing in an inflationary world

There is no guarantee that stock or bond markets will make any money next year – they too could fall in value. But, over the long term, investing has been proven to grow your wealth and beat inflation.
“UK Equity Income offers an antidote to this pain, especially if it can offer real yields and real growth,” continued Carl. “Throw in better economic news, a stock market that is ridiculously cheap versus all other major markets, and an environment where surely sentiment can only get better, then arguably there is a margin of safety in the sector that should warrant careful consideration by investors.”

Ned Naylor-Leyland, manager of Jupiter Gold & Silver, has another name for the environment we are in: shrinkflation. “That bar of chocolate you bought? It used to weigh 100 grams and now it’s 90 grams, but the price is unchanged,” he said. “That bag of crisps? It’s several potato slices lighter and has been rebranded. This is shrinkflation, and while it’s not new, it’s back with a vengeance and will be with us for some time, I believe.

“Gold is sometimes called a hedge against inflation, but it’s really a hedge against this more meaningful term for the public — loss of purchasing power. Gold can help to protect a portfolio against the effects of inflation. I see the current environment as ideal for owning gold due to structural problems with central bank policies as well as ongoing and worsening supply problems. Holding some gold, or an actively managed gold and silver fund, may be beneficial to offset these growing risks.”

“We see inflation peaking at the end of Q1 2022 and though part of it will be transitory, we do think there will be lingering and persistent inflation at a level significantly above most central banks targets,” added Mark Holman, a founding partner at TwentyFour Asset Management.

“The supply chain shocks that struck many sectors in recent months are likely to ease somewhat, but again we think these will remain a feature throughout 2022 and will test companies’ ability to protect their margins. This could well be one of the key determinants of corporate winners and losers in the coming year.”

Inflation is usually bad for fixed income as, like cash, it erodes the value of the bond’s coupon. So where are TwentyFour’s managers finding opportunities?

“Anything floating rate we think is worthy of consideration for 2022 as coupons rise with every base rate increase,” said Mark. “Financials also still look good relative value to us as they should be a beneficiary of rising rates and good credit performance.

“Top of our performance projection list is emerging market high yield corporates in hard currency, though. But this comes with a health warning; timing and patience are important, and our positive outlook here is based on the US Federal Reserve not being too far behind the curve and avoiding having to tighten more aggressively, so this is not a Q1 trade. In addition, a lot of what happens with this sector will have to do with the Chinese property market. Volatility is likely to remain very high in the short term, but high single-digit returns could be on the table for brave investors who get their timing right.”

Interestingly, only 42 out of some 5,076 funds available to UK investors currently have yields that match inflation*. M&G Emerging Markets Bond and Man GLG High Yield Opportunities, both on the Chelsea Selection, are among them.

Therefore, total returns in 2022 will be key to beating inflation.

*Source: FE fundinfo, 22 December 2022.

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 and yields will fluctuate. The views expressed are those of the author and fund managers and do not constitute financial advice.

Published on 04/01/2022