This article will explain how an extra-large portion of chips and the finest Stout is just one of a number of strategies being deployed by investment trusts to tackle the threat of a sustained period of inflation. But first…
“The Federal Reserve and several administrations have spent a decade post-financial crisis trying to create inflation and now, like tomato ketchup from a glass bottle, they’ve got too much all at once.” Ruffer Investment Co. Half-year Report 28 February 2022
UK interest rates/inflation: 1%/9% (March 2022). US interest rates/inflation: 0.75% to 1% range/8.5% (March 2022).
Compare these figures to their 12-month equivalents: UK interest rates stood at 0.1% and inflation at 1.5% (March 2021), while across the pond, interest rates were 0.00-0.25% and inflation was 2.6% (March 2021).
While there is no doubt inflation has reared its ugly head once more, questions remain. Chief among these is will inflation be temporary or permanent? What form will it take? Will it be volatile or sedate?
“We may not have permanently high inflation, but I think what we will have is pretty incessant volatility of inflation… the reasons behind this are many but I think the key one is that through COVID we’ve taken on a huge amount of debt in Western economies to fund the mechanisms like the furlough scheme and credit guarantee schemes to put money in people’s pockets to allow them to keep their jobs, to keep spending. This all costs money. Government debt has gone up and we are now in a position where it is very difficult for central banks and governments to raise interest rates to counter any inflationary threat…There seems to be general acknowledgement even amongst central banking circles that inflation is not transitory it will be here for longer than initially suspected.”
Whether or not readers subscribe to the view that factors such as the normalisation in economic activity following COVID and lockdowns, disruption to supply chains and the ongoing conflict in Ukraine have contributed to a temporary or more sustained spike in global prices protection against, inflation is now back on the agenda.
In the investment trust universe, help is never too far away. Solutions can be found for whatever needs an investor may have, or to take advantage of whichever prevailing macroeconomic winds are buffeting the global economy. An inflationary environment is no exception.
A first port of call is the Flexible Investment sector, home to absolute return trusts, such as Personal Assets and Ruffer, that have historically been, and are currently, positioned to protect against inflation. Both have material weightings to assets with strong inflation-hedging credentials. (Check out doceo.tv’s fund comparison tool here to find out more about these and other trusts in the Flexible Investment sector). As at end of February 2022, a third of Personal Assets was invested in global index-linked securities and a further 9% in gold bullion. As fund manager Sebastian Lyon wrote in the trust’s half-yearly report in October 2021:
“Gold bullion and inflation-protected securities provide a foil for our equity exposure, which in turn is focussed on durable, profitable companies that continue to grow and have pricing power.”
Similarly, just under 30% of Ruffer’s assets was invested in index-linked securities, a further 10% in gold and gold equities, and another 5% in short-dated bonds as at end of March 2022. As explained in its February 2022 Half-year report, Ruffer is a trust for all seasons:
“For bad market outcomes we’ve got the unconventional toolkit- index-linked bonds, credit protection, payer swaptions, gold exposure, and equity put options. This is what you would expect from Ruffer: a preoccupation with downside protection. For rosier outcomes – because there’s a chance we have another roaring twenties – we’ve got attractively priced GDP and inflation-sensitive equities.”
Broker JPMorganCazenove is a fan of both Personal Assets and Ruffer and has positive recommendations in place for the two trusts. Meanwhile, Personal Assets is included in Winterflood’s Model Portfolio.
Inflation protection, however, is not the preserve of Personal Assets and Ruffer and other like-minded absolute return funds. Investment trusts focused on real assets, such as infrastructure and property, can also act as a hedge against rising prices.
Speaking to doceo.tv in February 2022, Jonathan Parr, fund manager of Triple Point Energy Efficiency Infrastructure Company, described how revenues generated by the trust’s assets are linked to inflation. Using the fund’s recent acquisition of nine operational hydro power plants in Scotland as an example, Jonathan Parr explained:
“More than 90% of revenues from these projects are supported by feed-in tariffs and they are uplifted in line with RPI (retail price index) every year. The next uplift is due on 1 April (2022) and we’ve just had confirmed the RPI for the year from December, which will be used to apply the uplift from April, is 7.5%. This significant protection from inflation we think is really quite important. Also, in our acquisition model we had assumed RPI of 5%. So, 7.5% versus 5% will provide significant uplift to overall revenues and will therefore improve overall asset value.”
Dive deeper into the London market and trusts that invest in a wide variety of infrastructure assets can be found. Another fund within the Triple Point stable is Digital 9 Infrastructure. As the name suggests, this trust is focused on assets and companies within the digital infrastructure spectrum. Fund manager Thor Johnsen told doceo.tv:
“We’re providing a sustainable, predictable return which is comprised of a dividend. That dividend is backed by long-term contracts with inflation linkage. Of our (current) portfolio, 6.7 years is our weighted average contract term, of which 85% is inflation-linked.”
Property provides another example of how real assets can offer inherent inflation protection. European Logistics for example benefits from long-term structural drivers and also has inflation- hedging credentials. E-commerce growth and supply chain reconfiguration, both of which have been accelerated by the pandemic and associated lockdowns, account for two of the long-term dynamics that is driving demand for space in the sector. A third is supply struggling to match demand. These drivers are forcing rents for cutting-edge modern logistics facilities in prime locations higher.
So too, is the prevalence for standard lease agreements in Europe to be linked to CPI (consumer price indices). As Evert Castelein, fund manager of abrdn European Logistics Income, explains:
“In the year 2021, the average inflation in the Eurozone was 5%…on the Continent we normally benefit from full CPI indexation of rents year after year. So that will really help us to increase our income stream going forward.”
General REITs (Real Estate Investment Trusts) which invest in a broad spread of property sectors can also be positioned to weather an inflationary environment. In UK Commercial Property REIT’s most recent final results, fund managers, Will Fulton and Kerri Hunter wrote:
“We believe the industrial sector is best placed in the current inflationary environment as we have seen rental growth significantly outstrip inflation in strong locations. Alongside this, 26% of the portfolio’s income benefits from index-linked or fixed rental increases.”
As at the end of 2021, almost two thirds of UK Commercial Property’s portfolio was invested in industrials.
Equity funds too can prosper during bouts of inflation, provided they are invested in the right sectors and companies. This is what Murray International, run by Bruce Stout, is striving to do. In Murray International’s latest factsheet, the fund manager’s report points out today’s dangers and how the trust looks to avoid these:
“For many companies the inflationary backdrop now evolving is totally alien, and for those with highly geared balance sheets, wafer thin profit margins or negative free cash flows, such influences on the business environment will prove extremely hostile indeed. The portfolio will continue to avoid such companies in favour of a broad diversification of real assets, favouring business models and management that have proven capability of dealing with harsh and unpredictable operational conditions.”
One area currently favoured by Murray International is global semiconductors chips – as at 31 March 2022, names such as Taiwan Semiconductor, Broadcom and Samsung occupied three of the trust’s top 20 holdings. Arguably, it was a chronic shortage of semiconductor chips following the reopening of economies after pandemic-induced lockdowns that heralded the advent of the unprecedented disruption to global supply chains that is still at play today. At its worst, a lack of chips caused considerable disruption to a wide range of industries, most notably automakers, a number of which were forced to reduce, or even curtail, production. Chip manufacturers, such as those held by Bruce Stout and his team, therefore stand to benefit.
And there you have it – the promised explanation of how an extra-large portion of chips and the finest Stout is just one of the many ways in which investment trusts can help navigate today’s inflationary environment. Right, anyone up for a plate of chips and tomato ketchup?