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Inflation – an HL fund manager’s view

Inflation is back on investors’ agenda. HL Fund Manager Steve Clayton shares his view on inflation and tips to help beat it.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Inflation is the measure of how much prices have gone up over time. It’s the rate cash becomes less valuable – £1 this year will get you further than £1 next year. And it matters.

I know this because my lecturers at university talked about it a lot.

But that was in the 1980s. The world had just emerged from a decade of skyrocketing prices that caused havoc in the economy, destroying the real value of savings and creating industrial strife.

Inflation hit the UK hard and mortgage rates of 10% were quite normal. But then, so were flared jeans.

Since then, inflation has hardly been seen and interest rates have drifted lower and lower. Like inflation, the flares have sometimes threatened a comeback, but never with any real conviction.

But now the chatter about higher inflation returning is louder than ever.

This article isn’t personal advice. If you’re not sure if a course of action is right for you, ask for financial advice.

What could cause inflation?

Globalisation and the digital economy helped keep inflation low for decades. But further easing of restrictions has created risks that could allow it to rear up once more.

It might seem counter-intuitive. Because of the pandemic, the world has just suffered the worst slump in a century and unemployment is still a concern for many.

After all, no-one had ever ordered large parts of major economies to simply shut down and wait for the go-ahead to restart before.

But neither had governments spent untold billions on job protection schemes and massive business loan programmes. As a result, lots of households and businesses are emerging from the recession with unusually high levels of cash reserves.

Economies are now re-opening with a vigour that once seemed unlikely. But the recession left supply chains broken around the world, leading to some shortages. Companies slashed investment during the slump, so the ability to increase production is limited.

Governments are also still stepping on the gas, especially over in the States, where President Biden is pushing multi-trillion-dollar stimulus packages through Congress.

All of this leads to the risk of higher inflation.

Markets can sense that the risks of inflation are rising. This led to bonds having one of their roughest starts this year for some time. And recent stock market falls in the US and UK echo these concerns.

What does inflation mean for investors?

In an inflationary world, investors triumph by thinking in real terms. £1,000 in the bank will still be £1,000 in ten years’ time. But if inflation has averaged 3% above the level of interest earned, then the spending power of the deposit will have shrunk by a quarter in real terms.

Bonds are similarly challenged. Any bond that pays back a set amount in the future, with regular interest payments until then will see its real value eroded. Markets being markets, this tends to happen when they sense that inflation might accelerate, rather than over the life of the bond.

What about gold? They say it keeps its value. Perhaps. The price of gold is set by the balance of supply and demand in the market, day by day. Its value has indeed done well in keeping up with inflation over time. But there’s no link between gold and inflation. And if gold has a decade where its value fails to keep up, it won’t pay any interest or dividends in the meantime.

Shares have the potential to beat inflation and pay dividends in the process. And like gold, share prices are set by supply and demand in the market.

Remember though investments, and any income from them, rise and fall in value, so you could get back less than you invest. Past performance isn’t a guide to the future.

4 tips for picking shares to help beat inflation

The HL Select team uses these four rules as part of our process when choosing the companies we invest in. These traits underpin many of the world’s most successful growth stories.

Investing isn't right for everyone. You should make sure you understand what you're investing in, the specific risks, and make sure any investments you own are held as part of a diversified portfolio.

  1. Back the strong – when inflation rises, interest rates have typically followed soon enough. Businesses with large debts could struggle, especially if they have not locked-in today’s low interest rates.
  2. Cash is king – if inflation jumps, then economies feel the strain and there will be pressure across the board as everyone tries to adjust. Businesses that reliably generate cash as well as profit are much better placed to cope than those that don’t.
  3. Pricing power is critical – when inflation bites, companies can be hit with higher costs for everything from labour to IT equipment and rents. If they can’t raise their own prices, margins and profits will be squeezed. Consider sticking with businesses that have a history of being able to increase their own prices. Firms with strong intellectual property tend to score well here.
  4. Sticky is not icky – customers who keep coming back are a great asset for a business. The fact they keep coming back tells you that they value the product, so will likely bear a price increase without too much complaint. Businesses that sell on a subscription basis can have some of the most reliable revenues in town.

If investors can build a portfolio by picking companies using these rules, there’s a chance that over time it could cope with the impact of inflationary shocks in the economy. But it’s worth remembering there are no guarantees that the stock market will keep up with inflation.

I’ve always felt that the best way to invest is to back the strongest for the longest. Resilient businesses cope with whatever the economy throws their way, and can even emerge stronger from a downturn because weaker rivals failed along the way.

Steve Clayton is a fund manager of the HL Select range of funds.

HL Select Funds are managed by our sister company HL Fund Managers Ltd.

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Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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