What we are doing to help minimise the impact of inflation on your investments

Anyone with just half an eye on the news will know that many headlines in 2022 have been less than positive –war in Ukraine, the ongoing Covid-19 pandemic, increasing tensions between China and the US, to name just a few. The one common issue that many of these global crises contribute to is inflation. Why is inflation so high, what is the problem with it, and what are we doing about it? 

What causes inflation? 

Inflation – the measure of rising prices over time – has two main types. The first is when prices rise for products as it costs manufacturers more to make those products, for example rising energy costs for factories. This is known as cost-push inflation. The second type is when there is increased demand for a product, often because it is in short supply, which is known as demand-pull inflation.  

Generally, manufacturers will try to absorb small input cost rises themselves. However, when these input costs rise significantly, as is currently the case with energy prices, companies may be forced to pass this on to the consumer, or risk going out of business. Similarly, small fluctuations in the availability of a product may not cause the price for the end consumer to rise, but when there are large-scale shortages, such as the current grain shortage due to the conflict in Ukraine, then this could feed through into the price we pay for bread.  

A little of what you fancy does you good 

Let’s be clear, inflation is not inherently bad. In fact, a small amount of inflation is necessary for economic growth. Zero inflation means that businesses are not as profitable, wages stagnate, and consumers have less spending power. This is why many central banks, including the US Federal Reserve and the Bank of England, actively target 2% inflation in order to maintain healthy economies.

Too much of a good thing? 

However, when inflation rises too much it erodes the value of profits and savings. Price inflation typically rises faster than wage inflation and this can cause problems such as the current cost of living crisis. Too much inflation can also be bad for certain financial assets.  

For example, bonds that pay fixed levels of income usually perform well in low inflationary environments but underperform when there is higher inflation as this erodes the value of their income streams. Bonds that are linked to interest rates (index-linked bonds) also lose value when interest rates rise, which typically happens with medium to high inflation.  

Equities tend to perform well at low and medium inflation, but underperform at high inflation as company profits are impacted. Other asset classes, such as property and commodities, tend to perform well at medium and high inflation.  

Protecting and profiting

So, clearly the level of inflation is important when considering different asset classes. Protecting the capital you have invested is a key consideration for fund managers. But it’s not all about protection, there are also opportunities to profit when inflation is high. 

Don’t put all your eggs in one basket 

One thing we usually wouldn’t do is make big investment decisions one way or the other. Inflation is currently high, so pile into property and commodities, right? Well, if you are a high risk, short-term investor, you can choose to take that stance, but that is not how we invest.  

We prefer to invest in a diversified portfolio. This means lots of different asset classes across a wide range of geographies. We have the ability to change the balance of asset classes strategically over the medium term where we have strong views on performance, and also tactically, which helps us react to more shorter-term factors that affect our portfolios. 

The longer the better 

As portfolio managers, we have a long-term investment horizon. This typically means five years and beyond. It is hugely difficult to predict what asset classes will perform the best over the medium to longer term, and even more difficult (read pretty much impossible!) to ‘time the market’, i.e. know precisely when to buy and sell certain asset classes. The Covid-19pandemic is an example of a global event that no one predicted. It had a huge effect on economies and financial markets, and it was impossible to predict with certainty how and when markets would recover.  

We believe that a long-term, diversified portfolio is the best way to protect investments from global shocks whilst also taking advantage of the investment opportunities that they present.