How to protect your savings with inflation-linked investments

Savers and investors will have been relieved to learn that inflation slowed to 7.9 percent in June, after hitting record highs late last year.

However, this is a long way from the Bank of England’s 2% long-term inflation target, so the battle is far from over.

High inflation is still eating into the savings and pensions of thousands of people without inflation-linked protection.

There are a number of investments that provide a direct link to inflation or have strong inflation-fighting qualities.

We asked the experts what they are and how best to protect your investments.

Options for those looking to beat inflation include index-linked bonds, of which index-linked gilts are one type, infrastructure, commercial property, and real assets.

Experts also say that a well-diversified portfolio of stocks will offer a good hedge against inflation.

When it comes to protecting your pension funds and savings against inflation, Jason Hollands, director of corporate affairs at Evelyn Partners, advises: “An absolutely key baseline goal for savers and investors should be to achieve a level of return over the medium to long term that at least keeps pace with, and preferably beats, inflation.”

“If you don’t achieve this, it means the real value of your wealth is in decline, with the future purchasing power of your hard-earned wealth reduced.”

When it comes to the ideal allocation of inflation-linked assets to have in a portfolio, Hollands continues: ‘There is no one-size-fits-all exposure level, as it depends on your risk profile.

“In our most defensive portfolios, index-linked bonds, which have a direct link to inflation, currently fetch 6.7 percent, and exposure to assets like infrastructure where there is a partial direct link is typically 2 to 3 percent.”

Here are some ways investors can do this:

index bonds

Investors have traditionally been able to get inflation protection through index-linked bonds, although these have seen declines along with stocks in the past two years.

These are issued by the government, have a fixed cash flow (known as a coupon) and an expiration date. Indexed gilts are a type of bonus.

Hollands explains: “While most bonds pay a fixed rate of interest and mature at the value at which they were originally issued, certain bonds, such as index-linked gilts in the UK and inflation-protected or ‘tipped’ Treasury securities in the US, do not pay a fixed interest rate.

“In many ways, this should be seen as a de facto form of insurance to protect against inflation, and like most forms of insurance, the best time to implement it is when you don’t need it right away, such as when inflation is low or falling sharply.”

Some defensive multi-asset funds with an emphasis on capital preservation are heavily invested in inflation-linked bonds, particularly Personal Property Trustan investment trust managed by Troy Asset Management, which currently owns 34 percent of the portfolio in US-related Tips.

Laith Khalaf, Head of Investment Research at AJ Bell, agrees that “UK government-issued index-linked gilts are straightforward and widely accessible methods of hedge against inflation.

‘These bonds have their principal and interest payments adjusted for inflation, providing protection if prices rise, although they are long-lived assets, so prices will tend to fall with rising interest rates.

It is worth noting that the protection only works if the index bond is held to maturity.

Individual indexed gilts can be purchased through a broker, but the pricing is quite complex, so many investors may find it easier to use funds and ETFs.

Infrastructure assets are protected against inflation, as long contracts tend to include clauses that cause revenue to adjust for inflation each year.

Infrastructure and property

Infrastructure and property offer protection against inflation through indexed contracts.

Operational infrastructure projects, such as the management of transportation networks, prisons, hospitals, power transmission systems, are very long-term, with typical contracts lasting 20 to 30 years.

As such, Hollands explains: ‘It is very common for such contracts to include clauses that see earnings adjusted for inflation each year, making this asset class one that provides a high degree of inflation protection.

‘There are two key ways that private investors can access the infrastructure. The first is indirect, by investing in shares of publicly traded companies that are heavily involved in infrastructure, such as through funds like the Lazard Global Listed Infrastructure Equity fund.

But infrastructure is a very difficult asset to sell, so it is best accessed through investment funds. This is a more direct way to get exposure to real infrastructure projects.

Hollands says: ‘Our key choice right now is International public associationswhose objective is to provide shareholders with long-term inflation-linked returns by increasing their dividends and creating potential for capital appreciation.

INPP is targeting an annual dividend increase of 2.5 percent and a long-term total return of more than 7 percent per year.

The property may also offer inflation protection through inflation pegging.

Annabel Brodie Smith, director of communications for the Association of Investment Firms, says, “Some real estate investment firms generate income that is contractually linked to inflation through indexing or upward-only rent revisions, providing some comfort to income seekers when inflation is high.”

“Of course, dividends are never guaranteed and sentiment towards property and infrastructure has taken a hit recently due to rising interest rates. However, many analysts believe that these current conditions provide long-term buying opportunities.’

Khalaf likes commercial properties to hedge against inflation. “It’s traditionally considered a good inflation hedge because rental income and property values ​​tend to rise with inflation over the long term, and some commercial lease terms will have inflationary increases built into the contractual terms,” ​​he says.

Actions

Experts agree that one of the easiest ways for investors to protect their savings from inflation is to invest in a well-diversified portfolio of stocks.

Dzmitry Lipski, director of fund research at interactive Investor, explains: “Equities have proven to be the best diversifier against high inflation and have outperformed bonds and other asset classes over the longer term, but with higher volatility.

Energy, basic materials and banks have historically done better during periods of high inflation.

Hollands says this is because they “are components of rising prices themselves or, in the case of banks, benefit from the higher interest rates that inevitably follow when central banks seek to quell inflation.”

“The key qualities to look for in the long term are companies with strong and growing cash flows that are less vulnerable to price competition and therefore can defend their profit margins, pass cost increases on to customers, and provide goods or services that people will keep buying when the going gets tough.

‘Sectors here include areas like software, consumer staples companies, for example Unilever and Diageoand health. Funds that invest in companies that meet these types of characteristics include the TB Evenlode Global Income fund and the Liontrust UK Growth fund.