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Shares to help beat inflation – an HL fund manager’s view

Fund Manager Steve Clayton on the HL Select approach to seeking out shares that could beat inflation.

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.

You might not need reminding, but inflation is on the rise. It’s currently eating away at the real value of savings at an accelerating pace.

There are lots of root causes for the inflation we’re seeing. Global economies opening up after the pandemic and the invasion of Ukraine are part of the problem.

But what can investors do to protect themselves from inflation?

Now’s the time to be very picky about what to hold in portfolios. The HL Select team think companies whose products and services are so good and hard to replicate are well placed to protect the real value of their earnings.

Here are some of the things we look for in companies when picking shares to beat inflation for the HL Select funds.

This article is not personal advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment.

Investing in individual companies isn’t right for everyone – it’s higher risk than investing in funds as your investment is dependent on the fate of that company. If the company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

If you’re unsure whether an investment is right for you, ask for financial advice.

Pricing power

Pricing power is key. Here are some examples.

Take Rentokil Initial plc, one of the world’s leaders in pest control. Rats and mice don’t care about the rising cost of living and Rentokil’s customers need to have clean, hygienic facilities, regardless of the state of the economy. If not, they can’t operate.

In their recent trading update, Rentokil announced they had been fully able to pass all of their cost pressures onto customers, while delivering underlying revenue growth of 12%.

There are also essential services, like electricity and the supply of water which are provided by regulated utility companies. They’re allowed to raise their prices according to formulas linked to the level of inflation.

That means their earnings are well protected. Not only are their revenues linked to inflation, but their customers have to buy their services each and every day.

Pennon Group, owner of South West Water has given itself further protection from inflation through the acquisition of Bristol Water. This deal should allow Pennon to unlock extra profits from integrating the operations of Bristol Water into its own, creating a new stream of income that’s independent of the state of the economy.

National Grid handles the high voltage power lines that carry electricity from generator to local networks. National Grid recently guided that its profits would be a little better than previously expected, because of the impact of inflation.

But it’s not just utilities and pest control.

Imagine what would happen if your work computer no longer had Windows installed or Office. It could be difficult to find or use alternative software.

Unsurprising then that Microsoft feels able to raise prices each year. The company has leadership positions in many of its markets, from gaming to LinkedIn. Its Azure cloud computing division is second only to Amazon.

The group’s track record of growth is also extraordinary. Back around the turn of the century, Microsoft was earning around $14bn in revenues. The group passed through $100bn a couple of years ago and analysts expect Microsoft to report over $150bn at its next results.

The sheer strength of the company’s growth engine gives it great power to potentially deliver inflation-beating performance.

Repeat revenue

Knowing that your revenues will repeat is a huge advantage for any business. Knowing they’ll repeat at a pace linked to inflation even more so.

By and large, commercial rents are a great example of repeat revenue. If a tenant wishes to remain in their building, they must pay the rent.

And most commercial leases have clauses built into them allowing for the rents to be reviewed at regular intervals. This creates an opportunity to raise them to capture the effects of inflation. The income of the company owning the leases should therefore rise over time as rents are reviewed.

This growth in income isn’t dependent on speculative developments.

There are a number of companies listed on the market who focus on this creation of income-generating property portfolios rather than undertaking speculative developments. They look for high-quality tenants with long-term leases.

Here are two examples.

Primary Health Properties (PHP) owns hundreds of medical facilities, mainly Health Centres and GP Surgeries. So the large majority of PHP’s rents are paid by government agencies in the UK and Ireland, making them more secure than rent payable by private entities.

With rent reviews, typically every five years, the income has an inbuilt tendency to grow. So far, PHP has been able to grow its dividend every year for over 25 years.

Tritax Big Box REIT owns a portfolio of giant distribution centres, with Amazon the largest tenant. The growth of ecommerce is lifting demand for these buildings among retailers and parcel companies. These assets are scarce, as there aren’t many sites large and close enough to major roads. So rental growth prospects look very good and with a large portfolio of carefully assembled development sites, built up over many years.

Tritax has lots of growth potential which could support a rising dividend over time.

Remember though, dividends are variable and not guaranteed.

High margins

Pricing power coupled with a high gross margin is a great recipe for long-term, inflation-busting performance potential. One industry where it’s possible to find this combination is distilling.

Diageo owns Johnnie Walker scotch, Smirnoff vodka and many more. French company Pernod Ricard owns their namesake aniseed brands, but more importantly also has Absolut vodka, Beefeater gin and Jameson Irish Whiskey in its portfolio. Over in the US, Brown Forman owns Jack Daniels and Finlandia vodka. All three have performed far in excess of the wider global stock market over the last couple of decades, though this doesn’t mean this will continue as past performance isn’t a guide to the future.

The things you need to make spirits are little more than water, grains, energy and in the case of whiskies and cognacs, an awful lot of time. The brand strengths allow the brand owners to charge far in excess of cost, which makes the businesses highly cash generative.

Using the power of exceptional businesses to grow over time as part of a diversified investment strategy is one way to shelter wealth against the effects of inflation. But remember, all investments and any income they produce can fall as well as rise in value, so you could make a loss.

Steve Clayton is a Fund Manager of the HL Select range of funds, run by our sister company Hargreaves Lansdown Fund Managers Ltd.

Unless otherwise stated estimates are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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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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