Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
Inflation-busting investment trusts
UK inflation is at its highest level since October 2013, putting a squeeze on consumers’ wallets. The latest rate of 2.3% is above the Bank of England’s 2% target; and experts believe it will only get worse at the year goes on.
With this in mind, you need to ensure your investment returns exceed this rate of inflation to sustain the same standard of living to which you are accustomed.
We believe the topic of rising inflation won’t go anywhere, so we’ve pulled together another selection of fund suggestions, as picked by various experts.
Look out for solid track record
Sam Murphy, associate director of investment companies research at Numis Securities, expects corporate bonds to struggle in an inflationary environment, as the value of the fixed future cash flows are eroded in real terms.
‘Equities are likely to fare better as economic growth picks up, although given that input costs are also increasing, we favour companies with pricing power that enables them to maintain margins,’ he says.
One fund that he thinks could do well in this sort of environment is Ruffer Investment Company (RICA), which has a good long-term track record from investing in debt and equities with a focus on capital preservation.
‘The managers have been wary of inflation in the light of significant monetary stimulus from central banks around the world and hold
about 40% of the portfolio in inflation-linked debt securities. Such stimulus may also be a boon to economic growth, benefitting their 40% allocation to equities, which is focused on cyclical and financial names.’
Ruffer Investment Company is yielding 1.1% and is trading on a 2.2% premium to net asset value. Its shares are up nearly 25% in the past five years.
Equity income appeal
Research by the Association of Investment Companies (AIC) shows that an investment in the average UK Equity Income investment trust over the last 20 years would have more than doubled its capital value, with the annual income rising by 2% a year ahead of inflation.
Ryan Hughes, head of fund selection at AJ Bell Investments, suggests investors should look at Schroder Income Growth Investment Trust (SCF).
‘It concentrates on delivering a growing income in excess of inflation and is therefore very focused on the inflation expectations and outlook.
‘With 21 consecutive years of dividend increases, I expect it will look to protect this track record which should give confidence that inflation will be at the forefront of the manager’s thinking.’
The investment trust has a concentrated portfolio of 42 mainly blue chip companies and is yielding 3.9% with quarterly distributions.
The shares are up 47% over the last five years and are currently trading at an 8% discount to net asset value.
‘Sue Noffke, the manager, uses a bottom-up approach focusing on companies that offer real dividend growth, and sustainably high dividends or those increasing their pay-outs, but that are out of favour and trading at a discount,’ explains Hughes.
Many infrastructure funds have cash flows that are directly linked to inflation. A good example is International Public Partnerships (INPP).
The bulk of its portfolio is invested in energy transmission, education and transport assets, which offer long-term government-backed cash flows that are uncorrelated to equity markets.
Alan Brierley, director of the investment companies team at Canaccord Genuity, says that in a risk-off environment, he expects a marked polarisation in returns between the different alternative sectors.
‘When this happens, those “genuine alternative assets” that can deliver uncorrelated absolute returns will have significant value and we believe that companies such as International Public Partnerships, HICL Infrastructure (HICL) and their peers will be stand-out performers.’
International Public Partnerships targets a net asset value total return of 8-9% per year. It has a prospective dividend yield of 4.3% with two distributions a year and is trading on a 12.1% premium to net asset. The shares are up by a third in value over the past five years.
What about the property sector?
Another area that offers inflation protection is the specialist property sector. This has experienced significant growth over recent years as investors have sought out alternative sources of income to counter the low interest rates. The most recent addition to this area is Impact Healthcare REIT (IHR).
Innes Urquhart, investment trust analyst at Winterflood Securities, says that Impact Health raised £160m at the time of its launch last month.
‘The IPO proceeds will be used to acquire a diversified seed portfolio of up to 58 UK care homes let on 20 year leases, with rent payable under these leases subject to annual increases in line with RPI subject to a 4% upper limit and a 2% lower limit. As such this mitigates some of the risk associated with an increase in inflation.’
The fund will target quarterly dividends for the first 12 months following its launch equal to a yield of 6% per year on the issue price of 100p.
The shares currently trade at 103.5p, so you would theoretically qualify for a dividend yield in the region of 5.8%.