The funds on the up as inflation concerns mount

This type of fund tends to perform well in volatile markets and offers protection against inflation.

Gold funds shone in October on the back of increasing concerns over a sustained period of higher inflation.

Rising inflation has topped many investors’ ‘worry lists’ for months, but the signs suggest that it is here to stay for longer than central bankers were initially forecasting. Last week, as part of his Autumn Budget speech, chancellor Rishi Sunak said that inflation (the Consumer Prices Index, CPI) will average 4% next year. CPI inflation stood at 3.1% in September. To keep inflation at bay and drive it back down towards the Bank of England’s 2% target, interest rate rises are likely in the next couple of months.

Five of the top 10 fund performers for the month invest in the yellow metal, with returns ranging from 11.5% to 15%. Charteris Gold and Precious Metals and Ruffer Gold both returned 15%. Scroll to the bottom of the article for the top 10 fund performers. 

In terms of sectors, commodity/natural resources took the silver medal in October, up 5.5%, pipped by UK Index Linked Gilts, which gained 5.9%. Bonds that are index-linked are direct beneficiaries of rising inflation levels.

At the other end of the table, various specialist funds featured. Five funds produced double-digit losses: JPM Brazil Equity (-12.2%); Threadneedle Latin America (-12%); HSBC GIF Brazil Equity (-11.5%); Brown Advisory Latin American (-10.2%); and AQR Style Premia (-10%).

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Gold - the attractions and downsides 

Over the years and on long time horizons, gold has proved its value when it comes to protecting portfolios from volatile markets, including in periods of higher inflation. One reason is down to the fact that governments and central banks cannot simply print more gold, as they can currencies. As a result, its value is preserved.

Bear in mind, the precious metal is notoriously volatile over short-term time periods. Other downsides are that gold does not have a yield, and it does not generate cash flow or profit. Instead, its price simply reflects what the next person is prepared to pay for it, which is why it tends to be volatile. 

Due to previous metal and gold funds giving investors a rocky ride, it is prudent for investors to limit their exposure, restricting it to a small percentage of a diversified portfolio. Gold funds mainly invest in gold mining companies, which tend to rise and fall more than the gold price. 

Protecting against rising levels of inflation

Rising levels of inflation are challenging for both equity and bond markets. With equities, inflation is bad news for companies that do not possess pricing power and are price-takers rather than price-makers. For the bond market, inflation erodes the value of the income that bonds pay. As with equities, some types of bond are much more resilient than others in the face of rising prices, for example, short-duration bonds. Such bonds, which have a lifespan of a couple of years, are less sensitive to interest rates than long-duration bonds – bonds that have a lifespan of 20 or 30 years.

“As ever, balance in a portfolio is crucial,” points out Shore Financial Planning's Ben Yearsley, who supplied the fund statistics. 

In practice, this involves holding growth assets such as equities, which have the potential to outperform inflation over the longer term, alongside some bonds and alternatives (such as a small amount in gold), This results in diversification, which reduces taking on too much equity risk.

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David Jane, multi-asset fund manager at Premier Miton Investors, has been preparing for a period of sustained inflation by avoiding sectors that have benefited from historically low interest rates - utilities, consumer staples and pharmaceuticals.

Beneficiaries of higher inflation and increases in interest rates that Jane favours are energy, materials, banks and luxury goods. For the consumer-facing luxury goods sector, Jane points out that pricing power is a key ingredient to combat higher inflation.  

Jane adds: “Some businesses are widely recognised to suffer from higher inflation, an example being the fast-moving consumer goods business. Consumers are highly price sensitive, and supermarkets have huge power over their suppliers, such that despite these companies’ strong brands and defensible market positions, they have little ability to pass on higher input costs.

“On the other side of the coin, there are a number of industries which are traditionally regarded as having good pricing power, a classic case would be luxury goods, where consumers are either indifferent to price or even favour higher prices, and input costs are a very small part of the overall cost base. Other industries with strong pricing power include much of technology, in particular the software industry. In this case, frictional costs to change suppliers are high and input costs are a small part of the overall cost base.”

Other fund managers have been making changes to their portfolios in response to the increases in the cost of living. Nick Train, fund manager of LF Lindsell Train UK Equity, a member of interactive investor’s Super 60 list, recently said: “We want more luxury, more premium, more pricing power in the portfolio. This is why we will continue to build the holding in Fevertree (LSE:FEVR).”

Train added: “It is also why Diageo (LSE:DGE) is so important for the fund – currently the second-largest holding, just behind RELX (LSE:REL). With each passing year, more of Diaego’s growth and value is accounted for by its super-premium and premium brands.”

Burberry (LSE:BRBY) and Rémy Cointreau (EURONEXT:RCO), the French spirits company, are two other examples of luxury goods companies that have the ability to “protect shareholders against the effects of inflation”, according to Train.  

Top-performing funds in October 

Source: FE Analytics. Performance from 30 September 2021 to 30 October 2021.