INFLATION can seriously erode the value of your wealth, so investing wisely is imperative. While the current outlook sees interest rates on hold for longer, inflation continues to surprise on the upside. UK GDP grew a measly 0.2 per cent over the last quarter and data released yesterday showed industrial production contracted in July after stagnating in June. With such weakness in the economy, the government is unlikely to raise rates until at least the latter part of next year and indeed the Bank of England’s Monetary Policy Committee voted unanimously to maintain rates last month. However, inflation figures are not only above the 3 per cent mid-term target for price stability, but at 4.4 per cent are even higher than the majority of economist forecasts.
With prices rising, your pound doesn’t go as far as it used to. And with rates on hold, the situation is deteriorating, so it’s worthwhile deciding how you should be positioned if higher inflation kicks in.
In general, inflation is bad for traditional bonds, can make equities a controversial call but is superb for hard assets. A typical bond pays a fixed rate of income; as inflation drives interest rates above this level, its price will fall to maintain an attractive yield and compete with the return, for example, building societies will be offering. When it comes to equities, focus on the top line can be illusory. A company’s sales may not increase as prices increase, due to falling demand, but even if it does, so will costs and expansion plans will have to be funded with more expensive debt. In contrast gold is a store of value and property can provide attractive returns if supply is limited.
However, there is always a caveat. Maintaining a diversified portfolio is imperative to generate steadier returns and each asset class can still have a place in portfolios. With respect to bonds, there are inflation-linked bonds which target a return above inflation. For equities, there are companies better able to pass on price increases without substantial change in demand. For example, a consumer staple may provide essential, price agnostic products. Furthermore, firms with strong balance sheets have low levels of debt to service. When it comes to gold, a fall of over 7 per cent over just two days last month shows the asset isn’t as safe as investors may hope. And property remains a very broad classification, with many factors determining return.
Therefore, a diversified portfolio among the different asset classes, paying particular attention to the investments chosen for each should stand you in good stead.
Gemma Godfrey is chairman of the investment committee at Credo Capital. A former hedge fund manager and quantum physicist, she has regular slots on CNBC and Sky News.