For a supposedly “transitory” phenomenon, inflation has proved depressingly resilient in the major economies over the past year.
In August 2021, the Bank of England said price rises were likely to peak at an annual rate of 4%; instead, they soared to a 42-year high of 11.1% in late 2022. Inflation has also reached its highest levels in four decades in the US and the eurozone.
“Markets were caught off-guard by the return of inflation just as badly as central bankers,” says The Economist. “The danger now is that they underestimate its persistence.”
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What has driven inflation?
More than a decade of money printing, along with strong fiscal stimuli and broken supply chains during the pandemic, caused the initial surge. In Britain consumer price inflation has now edged downwards, but the strongest pay growth on record (excluding the Covid period) in the final quarter of 2022, 6.7%, is unsettling, as higher wages often lead to higher prices; food-price inflation also remains resilient.
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In the US, too, the tight labour market suggests that underlying inflation is still strong, as does the gradual recent acceleration in core inflation (inflation adjusted for volatile food and energy prices). There is also the near-term danger of another surge in energy prices as China’s economy finally reopens.
Historical precedent is inauspicious too. Deutsche Bank recently assessed 318 separate occasions since 1920 – in both developed and emerging markets – where annual price rises had reached 8%. It typically took two years for them to retreat below 6%, “before settling around that level out to five years after the initial 8% shock”.
Structural disinflationary tailwinds such as globalisation and China’s integration into the world economy, moreover, have stalled. We also strongly suspect that relatively high inflation suits central banks: it erodes the real value of our eye-watering debt piles, which higher interest rates are rendering more and more onerous.
Bear in mind that with annual inflation of 8%, the value of your money halves in nine years. The upshot is that growing the real value of your capital and your income is likely to be an uphill struggle over the next few years.
Investment trusts for inflationary times
So what are the best investments to put in your individual savings account (ISA) in an environment of structurally high inflation?
Investing in raw materials, notably energy and metals, can provide some protection, as rising prices of commodities fuel the overall trend. Two funds to consider in this context are the BlackRock World Mining Trust (LSE: BRWM), which holds big global mining stocks, and BlackRock Energy and Resources Income Trust (LSE: BERI), which holds both major miners and oil and gas giants.
Consider property and income trusts. Real-estate funds where rental income is linked to inflation can be helpful too. One idea MoneyWeek highlighted recently is Supermarket Income Reit (LSE: SUPR), a real-estate investment trusts that rents out buildings to supermarkets; 81% of its leases are linked to inflation.
Infrastructure funds could also maintain their value as prices rise given the vital nature of assets such as bridges and roads, as The Telegraph points out – the 3i Infrastructure fund (LSE: 3IN) is worth researching – while index-linked bonds pay out interest that rises with inflation, preventing higher prices from eroding the debt’s value. You can buy them directly from brokers or the government’s Debt Management Office.
Linkers comprise 44% of the Capital Gearing Trust’s (LSE: CGT) portfolio, while it also offers exposure to infrastructure and property. An inflationary structural backdrop is bad news for overpriced growth sectors such as technology (higher interest rates reduce the present value of future earnings) but bodes well for markets replete with “value” stocks (solid, reasonably priced equities) such as the FTSE 100.
Britain’s blue-chip index is cheap compared with its counterparts in other developed countries and is skewed towards traditional value sectors such as oil and miners as well as large consumer-goods groups with ample pricing power. One simple FTSE-100 tracker is the iShares Core FTSE 100 UCITS ETF (LSE: ISF).
Income is at a premium in times of high inflation, so some UK income funds such as the Finsbury Growth and Income Trust (LSE: FGT) and the City of London Investment Trust (LSE: CTY), which has raised its dividends for 56 consecutive years, are worth a look.
A globally focused option is JPM Global Growth & Income (LSE: JGGI) investment trust, which is skewed towards the US. The Murray International Trust (LSE: MINT) holds around a quarter of its assets in the US and Asia respectively.
Finally, there is gold, the ultimate safe haven and store of value. Gold bugs point out that an ounce of gold has been able to buy a men’s suit for centuries. We think investors should have 5%-10% of their portfolio in gold as a form of insurance. You can track the gold price with one exchange-traded fund such as Wisdom Tree Physical Gold (LSE: PHGP).
