The last time inflation was this high at 9.4%, Bucks Fizz and Adam Ant were high on the pop charts around 40 years ago. The fact that it was so long ago explains why many investment managers and private investors are scrambling to identify the companies best positioned to deal with it.
“Which companies will do best in a time of high inflation is a difficult question to answer,” admits Ben Yearsley, chief investment officer of Shore Financial Planning in Plymouth, Devon.
It’s the understatement of the year when he adds: “Inflation and the possibility of a recession are far from ideal when it comes to investing in the stock market.
New Growth: Many investment managers and private investors are scrambling to identify companies best positioned to weather rising inflation
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Laith Khalaf, head of analytics at wealth manager AJ Bell, has some words of comfort for worried investors. He says: “Although the UK economy looks likely to be heading into recession, investors can take comfort in the fact that the Bank of England’s catastrophic economic forecast, announced ten days ago when it announced pushed interest rates to 1.75%, barely caused a ripple in the UK stock market.
“That’s because the market had already priced in a bad economic outlook and drove stock prices down.”
So far this year, despite a series of interest rate hikes, steadily rising energy bills and a difficult economic environment, the UK stock market has held up remarkably well.
The FTSE100 index of major UK listed companies has been flat – up 0.03% – year-to-date, while the FTSE All-Share is down 2.9%. To put these numbers into context, the S&P 500 index – the US equivalent of the FTSE100 – is down more than 12%.
David Coombs is head of multi-asset investments at wealth manager Rathbones. He says the companies best positioned to weather inflation are those that have low levels of debt and generate lots of cash flow. He also likes companies that provide a premium service or product, or that manufacture consumer staples – food and drink, the latest items to be cut from the household budget.
He adds: “Our goal as fund managers is to try to identify companies that possess most of these characteristics. Still, it’s a more subjective process than you might think — and it changes over time.
“Typically, we think of Heinz ketchup, Colgate toothpaste, and shredded wheat as commodities. But in today’s world, consumer staples include Google, cellphone contracts, broadband and maybe Amazon Prime.
He adds: “The success of low-cost retailers such as Lidl, Aldi, B&M, Dollar General and Poundworld is a major threat to the commodities of the past 20 years.” Coombs says his “resilience” investment portfolio would include shares of Apple, Alphabet, the London Stock Exchange (LSE), data specialist Equinix, wholesaler Costco, medical device companies Thermo Fisher and Dexcom and pharmaceutical giants such as Roche. All of these companies except LSE (UK) and Roche (Switzerland) are listed in the United States.
Stuart Gray is co-manager of Alliance, a £2.9bn global investment trust. More than half of its assets are in the United States. Still, his performance held up well.
Over the past year it has generated an overall loss of 0.3% and over the past five years it has produced a return of nearly 50%. Reassuringly for investors, it continues to provide a growing dividend through thick and thin.
Only one rival trust, City of London, has a longer dividend growth record – 56 years compared to Alliance’s 55.
Gray argues that “diverse stock selection” is a good way to deal with a variety of market environments, including an inflationary environment. Like Coombs, he is attracted to companies that aren’t too leveraged and don’t need a lot of capital to grow their business and revenue.
He says US-listed software provider Intuit is a prime example. He also prefers companies that have pricing power because of their loyal customer base, such as US aerospace component maker TransDigm, or have the ability to charge fees based on the price of goods sold, such as US financial firm Visa. . His income, he argues, should rise as prices rise in an inflationary environment.
He adds, “Companies with fundamental strengths like these are well positioned to weather the current inflationary environment and grow in value over the long term.
Investment funds that try to beat inflation
Another good way for investors to build resilience in their portfolios, according to Shore’s Ben Yearsley, is to gain exposure to investment funds that seek to protect the “real” value of investors’ capital over the medium term. They tend to do this by investing in a range of assets, not just stocks.
Investment trusts created for this purpose include Personal Assets, Capital Gearing and RIT Capital Partners.
For example, Personal Assets, managed by Troy Asset Management, has generated returns above inflation – and the FTSE All-Share Index – over the past three and five years.
Over the past year, returns have not kept pace with inflation, but the trust’s investment objectives emphasize that fighting inflation is a long-term goal, not a short-term one. The current portfolio includes a mix of exposure to gold (12%), index-linked bonds (35%) and equities (quality brands such as Microsoft, Visa, Unilever and beverage giant Diageo).
A number of multi-asset funds take the same type of approach as Personal Assets, investing in bonds, gold and stocks.
For example, Rathbone Strategic Growth Portfolio, managed by Coombs, also invests in gold and bonds as well as quality companies such as Alphabet, Amazon and Mastercard. Over the past five years, it has generated returns of 28%. Similar funds include Liontrust Balanced and Waverton Portfolio.
Yearsley also says investors should apply a rule on Lazard Thematic Inflation Opportunities, a recently launched fund that invests in companies that managers believe will thrive in an inflationary environment.
His portfolio is once again skewed towards consumer staples companies. Among its major holdings are Costco, as well as energy companies Shell and Equinor. The fund will soon be available for purchase through major wealth management platforms.
Trusts that invest in infrastructure projects – whose earnings are linked to inflation – and renewable energy are also worth considering.
These include First Sentier Responsible Listed Infrastructure – of which Yearsley is a fan – Foresight Solar and Greencoat UK Wind.
Gresham House Energy Storage Fund is rated by Adil Alaoui, analyst at investment house Sarasin & Partners. He says: “Energy storage will help the UK decarbonise as more renewables come onto the grid. The trust continues to be the market leader in battery storage in the UK, with a market share of around 30%.
“It delivered strong performance, as a beneficiary of high-powered price volatility and strong operational performance.”
Since the beginning of the year, its share price has increased by 26%.
Another tactic in times of uncertainty is to target income-friendly investment funds.
Adrian Lowery, of wealth manager Evelyn Partners, says: “Income gives investors a comfortable hedge when the value of their stocks goes nowhere, or even falls. Funds worth looking into, he says, include Guinness Global Equity Income and Temple Bar.
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