Golden days?
Can commodities protect us? The AIC’s Commodities and Natural Resources sector is our best-performing year-to-date, up 29 per cent. But caution is warranted.
Commodity prices are volatile and sensitive to the business cycle. If oil hits $200 a barrel the economy cools.
Gold is even less reliable as an inflation hedge. Its price in real terms has been all over the place in recent decades, and has very weak correlation with inflation over any mortal time horizon.
What all of this tells us is that there is no silver (or gold) bullet when it comes to delivering real returns in highly inflationary times. No one asset class will reliably do it, and a conventional multi-asset portfolio looks vulnerable too.
The good news (finally!) is that by looking within asset classes and being selective, it’s possible to increase portfolios’ inflation protection.
There are three investment companies that have a reputation for being obsessed by inflation: I’ve mentioned two already, Personal Assets Trust and Capital Gearing, and the third is Ruffer Investment Company. It is well worth taking a look at how inflation-obsessed people put together a portfolio.
There are plenty of similarities. All three have around a third of the portfolio in index-linked government bonds (UK or US). With principal and coupon payments both linked to inflation, their attractions are obvious.
However, a lot of the action is in the price movements. They do well when expected inflation is higher than the yields of conventional bonds, as it is at the moment.
If that gap narrows – either because of lower inflation expectations or higher interest rates – their prices fall. But if inflation really takes off, they could produce exceptionally good returns.
All three have exposure to equities of around 40 per cent.
Charlotte Yonge of Personal Assets says the company has an “equity first” philosophy, but has nevertheless trimmed its exposure recently, reflecting concern over valuations.
It tries to build in inflation protection by investing in companies with pricing power, providing essential products and services, and where revenues are inflation-linked (Visa is a good example).
Capital Gearing’s Laing mentions that Japanese equities are relatively attractive, as it’s one market where a pickup in inflation could actually be a positive.
He also likes the UK, which he believes is still languishing under a Brexit discount, and which has plenty of exposure to energy, financials and commodities, all of which he expects to prosper in more inflationary environments.
All three investment companies also have some exposure to gold and cash – Ruffer’s cash balance is highest at 15 per cent. The latter exerts an obvious drag on real returns but provides dry powder which can be useful in volatile markets.
