A recent Fidelity white paper predicted there is a significant risk that inflation will rise materially in the medium term beyond target levels in key European markets. This will be driven by delays in the withdrawal of liquidity by central banks as economic multipliers recover and by unanticipated supply shocks in food and resources markets.
Elsewhere, and again referring to the ‘medium term’, Capital Economics continues to believe that inflationary concerns are overdone and that slack in the economy, at home at least, will keep a lid on underlying price pressures.
The equity option
There’s no great consensus then, but that doesn’t mean you shouldn’t be protecting yourself. The best recognised inflation hedge is of course equities, though a higher allocation to shares will not necessarily suit all clients.
As Tom Stevenson, investment director at Fidelity recently told Portfolio Adviser: “In a modestly inflationary environment, equities are a good hedge against rising prices. Shares represent a real claim on a company’s assets and cashflows, which can rise in line with prices if a company has any pricing power.”
Other so-called real assets, such as gold, property, infrastructure or even wine and classic cars have their merits, though it is unlikely that these will make up a large part of any portfolio.
For Caspar Rock, CIO at Architas, a good start is to look at fixed income allocation; he advocates sticking to short duration bond funds or using holding floating rate notes where the coupon liked to short-term interest rates.
“Base rates should rise to curb inflation and the yield on these bonds will go up accordingly, but as future repayment of capital is fixed, this paper offers little in the way of longer-term inflation proofing,” he says.
The whole mix
It’s clear that inflation proofing spans the whole asset mix and that subtle adjustments can go a long way – inflation is clearly a different threat to returns than a market slump, and as such calls for a different way of trading ‘defensively’.
James Smith has written a cracking article on this very topic. Read it the latest May edition of Portfolio Adviser, out now.
