How to protect your nest egg with inflation-linked investments

Savers and investors will have been relieved to learn that inflation slowed to 7.9 per cent in June, following record highs late last year.

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

High inflation is still eating into the nest eggs and pensions of thousands who don’t have inflation-linked protection.

There are a number of investments that either provide a direct linkage to inflation, or have strong inflation-beating qualities.

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

Feasting on returns: Inflation has been eating into savings and investments, but there are ways to protect your nest egg with explicit inflation-linked assets and equities

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

Experts also say a well-diversified portfolio of equities will offer a good inflation hedge. 

When it comes to protecting your pension pots and nest eggs from inflation, Jason Hollands, director of corporate affairs at Evelyn Partners advises: ‘An absolutely key, first base objective for savers and investors should be to achieve a level of return over the medium to longer-term that at least keeps pace with inflation, and preferably beats it.

‘Failure to achieve this means the real value of your wealth is in decline, with the future spending power of your hard-earned wealth reduced.’

When it comes to the ideal allocation of inflation-linked assets you should have in a portfolio, Hollands continues: ‘There isn’t a one-size all level of exposure, as it depends on your risk profile.

‘In our more defensive portfolios, index-linked bonds – which have a direct link to inflation – are currently up to 6.7 per cent, and exposure to assets like infrastructure where there is partial direct linkage is typically 2 to 3 per cent.’

Here are some ways investors can do this:

Index-linked bonds

Traditionally, investors have been able to get inflation protection through index-linked bonds, though these have seen falls along with equities in the last two years.

These are issued by the Government, have a fixed cash flow stream (known as the coupon) and a date of maturation. Index-linked gilts are a type of bond.

Hollands explains: ‘While most bonds pay a fixed rate of interest and mature at the value they were originally issued at, certain bonds – like index-linked gilts in the UK and Treasury Inflation-Protected Securities or ‘Tips’ in the US, pay interest and have a face value that adjusts linked to an inflation index, such as CPI in the US, or RPI in the UK.

‘In many ways, this should be considered as a form of de facto insurance to protect against inflation and, like most forms of insurance, the best time to put it in place is when you don’t immediately need it, such as when inflation is low or in sharp retreat.’

Some defensive multi-asset funds with an emphasis on capital preservation are heavily invested in inflation-linked bonds, notably Personal Assets Trust, an investment trust managed by Troy Asset Management, which currently holds 34 per cent of the portfolio in US related Tips.

Laith Khalaf, AJ Bell head of investment analysis agrees that ‘UK government-issued, index-linked gilts are direct and widely accessible methods to hedge against inflation.

‘These bonds have their principal and interest payments adjusted in line with inflation, providing protection if prices rise, though they are long duration assets so prices will tend to fall with rising interest rates.

It is worth noting that the protection only operates if the index-linked bond is held to maturity.

Individual index-linked gilts can be bought through a broker, but pricing is quite complex, so many investors may find it easier to use funds and ETFs.

Infrastructure assets have inflation-protection as long contracts tend to include clauses that see revenues adjusted for inflation each year

Infrastructure and property

Infrastructure and property offer inflation protection by way of indexed contracts.

Operational infrastructure projects – such as managing transport networks, prisons, hospitals, power transmission systems – are very long-term in nature, with typical contracts lasting 20 to 30 years.

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

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

But infrastructure is very hard-to-sell asset, so is best accessed through investment trusts. This is a more direct way to get exposure to actual infrastructure projects.

Hollands says: ‘Our key pick currently is International Public Partnerships, which aims to provide shareholders with long-term inflation-linked returns by growing its dividend and creating the potential for capital appreciation.’

INPP targets an annual dividend increase of 2.5 per cent, and a long-term total return in excess of 7 per cent per annum.

Property can also offer protection from inflation through inflation linkage.

Annabel Brodie Smith, communications director of the Association of Investment Companies says: ‘Some property investment companies deliver income which is contractually linked to inflation through indexing or upward-only rent reviews, providing some comfort to income seekers when inflation is high. 

‘Of course, dividends are never guaranteed and sentiment towards property and infrastructure has suffered recently as interest rates have increased. However, many analysts believe these current conditions provide long-term buying opportunities.’

Khalaf likes commercial property for inflation protection. ‘It is traditionally viewed as a good hedge against inflation because rental income and property values tend to increase with inflation over the long term, and some commercial lease terms will have inflationary rises built into the contractual terms,’ he says. 

Equities

The experts agree that one of the simplest for investors to protect their savings from inflation is by investing in a well-diversified portfolio of equities.

Dzmitry Lipski, head of funds research at interactive investor, explains: ‘Equities have proven 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 fared better during periods of elevated inflation.

Hollands says this is because ‘they are either components of rising prices themselves or – in the case of banks – benefit from the higher interest rates that inevitably follow as central banks seek to quell inflation.’

‘The key qualities to look for over the long term are businesses with strong and growing cash flows that are less vulnerable to price-based competition and are therefore able to defend their profit margins, pass on cost increases to customers and which provide goods or services people will still buy when the going gets tough.

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

This post first appeared on Dailymail.co.uk