Inflation is racing ahead, so what does this mean for your savings and investments?

UK consumer price inflation (CPI) hit its highest level for two and a half years in December 2016 according to the latest figures from the Office of National Statistics (ONS).

Inflation can eat into your saving and investment returns, and thereby erode the real value of your assets.

The CPI figure of 1.6% was 0.2% north of the consensus figure as the sharp fall in sterling pushed up import prices.

Why should I care about a mere 1.6% inflation?

The Bank of England has long targeted for 2% inflation, so why all the fuss about a figure 0.4% below this level? The latest inflation figure is important because it is rising fast – and could easily exceed the BoE’s goal in the very near future.

We warned several times in Shares last year of the impending rise in the cost of living. The situation is now becoming very real.

The weak pound has made it more expensive to buy goods from abroad and these extra input costs are either being passed on to consumers or eating into corporate profit margins.

Shilen Shah, Bond Strategist at Investec Wealth & Investment, still believes inflation is likely to overshoot the BoE’s inflation target in 2017, however the near term determinant will be the reaction of sterling and the domestic demand.

I thought the UK had a healthy economy?

Consumer demand has generally been robust since the Brexit vote last summer. The latest GDP figures are due to be published today (26 Jan).

The economy still looks susceptible to reduced business investment and/or a slowdown in job hiring as Brexit negotiations start to take shape.

So where should I put my money?

‘Traditionally, equity investment has been seen as a good counter to inflationary pressure if that pressure is caused by a strong growing economy,’ says Andrew Summers, Head of Collectives, Investec Wealth & Investment. ‘(That could lead to) higher profits and willingness by investors to buy riskier companies which will drive share prices higher.’

He suggests assets which may do well in a high economic growth environment include property (where values could benefit from rising rents) and corporate bonds (where values benefit from increased demand for risk assets in general).

‘In contrast, government bonds are a bad investment as both the coupons paid (interest) and the principal (initial sum) to be returned is fixed and thus lose value through inflation.’

Other investments suitable for an inflationary environment include commodity producers. Gold has historically provided a hedge against inflation and funds are ideal for anyone who wants the upside of backing a gold miner but does not want to buy individual stocks.

For instance, exposure to multiple companies through a single product is on offer through BlackRock Gold & General D Acc (GB00B5ZNJ896).

Inflation-linked bonds should also appeal in an inflationary environment. You may find it easier to buy a fund or investment trust that already has such bonds in its portfolio, with Capital Gearing Trust (CGT) being one example.

Look for investments with dividend growth

Stocks that can grow their dividend payments at least in line with inflation, such as utility companies or those blessed with considerable pricing power, should also be on your shopping list.

A good fund in the investment trust sector for dividend growth is Perpetual Income & Growth (PLI), run by Invesco Perpetual fund manager Mark Barnett.

In the open-ended funds universe, we like Evenlode Income (GB00B40Y5R17). Its lead manager Hugh Yarrow focuses on sustainable real dividend growth generated by companies with high returns on capital and strong free cash flow.

The fund has returned 91.5% on a cumulative five year basis versus 64.5% for the IA UK All Companies sector according to Trustnet.

Top 10 holdings feature a range of companies with pricing power. They include consumer goods powerhouse Unilever (ULVR) and Tampax tampon seller Procter & Gamble (PG:NYSE).

Top pick for equity income

Ryan Hughes, head of fund selection at AJ Bell, believes a high quality equity income fund should sit nicely alongside the aforementioned investment trusts. His top choice is Artemis Income (GB00B2PLJJ36).

‘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,’ says Hughes.

‘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.’

Back some quality names

Fundsmith Equity (GB00B4MR8G82) 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 IA Global sector.

Top holdings include technology giant Microsoft (MSFT:NDQ) and tobacco titan Philip Morris International (PM:NYSE). (JC)

[DISCLAIMER] Daniel Coatsworth, who edited this article, has an investment in Fundsmith Equity

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