Inflation is creeping towards the top of some fund managers’ worry lists for 2021. Hannah Smith explains how fund investors can add some inflation-proofing to their portfolios.
Inflation is a force investors need to consider when building and future-proofing portfolios, but right now opinion is divided on whether inflation is set to take off or remain subdued from here.
One of the main arguments for the return of inflation globally is the huge amount of stimulus the Bank of England and other central banks have been throwing at the coronavirus crisis. Just this week as England entered a second national lockdown, the Bank added an extra £150 billion of quantitative easing (QE) by buying up government bonds, taking the total stock of government bond purchases to £875 billion.
In addition, the Bank of England has not ruled out using negative interest rates to support the economy through the second wave of Covid-19, and the impact of Brexit. It may also buy different types of assets, including corporate bonds, high-yield bonds or even stocks.
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The US, too, has been stepping hard on the QE gas pedal this year, having pumped $2 trillion (£1.5 trillion) into its economy during the pandemic, and whoever wins the White House will likely unleash even more. But 10 years of QE since the financial crisis has not caused inflation to rise. In the UK, consumer prices inflation is at just 0.5%, although the Bank of England expects it to return to its 2% target within two years.
This time, however, things are different, says Dean Cheeseman, multi-asset portfolio manager at Janus Henderson. That’s because this time the money that has been printed is leaking out of the financial system and trickling down into the real economy. In the US, for example, the government put an actual $1,200 stimulus cheque in people’s hands and encouraged them to spend it.
Huge national debt
A result of this vast QE spending, though, has been the build-up of enormous debt piles and governments will be looking to use higher inflation as a way to reduce it, some commentators suggest. Steve Russell, co-manager of the Ruffer Total Return fund, who thinks that inflation will have to do the heavy lifting to repay this debt, which is too large to be tackled though tax revenues.
“The coronavirus pandemic has hit public finances like a war and across the world governments have scrambled to offset the economic impact. UK government debt now tops £2 trillion, while the US owes an eye-watering $26 trillion, and the picture is similar across Europe with many countries seeing debt/GDP ratios rising to over 100%,” he says.
“Such debt levels are simply too big to be repaid through tax rises. Inflation, not growth, austerity or taxation, will have to do the heavy lifting, which poses the greatest risk to savers today.”
However, central banks have been desperate to do this for the last few years, notes Tom Becket, chief investment officer at Punter Southall Wealth, and have so far failed to use “financial alchemy and cheating” to bring down debt levels.
Other inflationary forces at play right now include a possible Trump election win – his drive to onshore manufacturing could push up the cost of production and mean manufacturers pass on the costs to consumers in higher goods prices, says Cheeseman. He also notes that in August the Federal Reserve changed its inflation target from 2% to “a flexible average of 2%, so my takeaway from that is that they are going to let inflation overshoot”, he says. Climate change, too, could be a factor in higher inflation longer term, as crop failures push up food prices. And, of course, there’s Covid-19, which has disrupted supply chains and transportation, leading to more expensive goods.
“I am increasingly of the view that inflation risks are rising,” says Becket. “A key reason why inflation rates may pick up is that stimulus is enormous now, and the second reason is the missing link – UK Bounce Back loans and PPP [Paycheck Protection Program] loans in the US, which put the taxpayer on the hook for loan impairments rather than the banks.”
A “blue wave” landslide for Joe Biden would also have been inflationary, adds Becket, but now even if he wins the election, Biden may struggle to get huge stimulus programmes approved by the Senate. This could lead to lower inflation than would otherwise have been the case.
But what are the other arguments against rising inflation? Higher unemployment creates slack in the economy – Sainsbury’s (LSE:SBRY) has just announced it will cut 3,500 jobs, and there are hiring freezes and wage freezes in play at many firms already, notes Cheeseman. Higher taxes to pay for rising government debt could reduce people’s spending power, and even our demographics of an ageing population mean lower productivity and lower consumer spending.
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Cheeseman, though, is in the rising inflation camp, and has been preparing portfolios for this scenario. He has rotated his inflation-linked bond positions into US Treasuries, and has around 5% in gold ETFs.
In an inflationary environment, he expects infrastructure to do well, and favours investment trusts such as 3i Infrastructure (LSE:3IN), HICL Infrastructure (LSE:HICL), and the Renewables Infrastructure Group (LSE:TRIG), as well as renewable energy companies Foresight Solar (LSE:FSFL) and Greencoat UK Wind (LSE:UKW). Cheeseman is also looking at value funds, including Jupiter Special Situations.
Ruffer’s investment managers have put more than 40% of their portfolios into inflation-linked bonds and gold as an inflation hedge.
Becket agrees that it makes sense to have gold equities in a portfolio. Gold companies have enjoyed rising earnings, while bullion prices are high and input costs have remained low due to a subdued oil price.
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