We have mentioned inflation in this column before, as we believe it is one of the biggest threat to charities and indeed all savers. It is now in the news again as we emerge from lockdown and pent-up demand meets supply constraints.
Most of today’s investors have never seen significant inflation, so it is worth knowing how different asset classes might fare in an inflationary regime.
Cash – if interest rates are kept below inflation, as the US Federal Reserve has promised, then huge amounts of cash and money market funds will seek inflation-proof homes.
Bonds – between 1946 and 1981, 30-year US Treasuries and British Consols respectively lost 80% and 97% of their purchasing power, according to Reuters. Higher inflation now will ring the death knell for the bull market in conventional bonds and spell the end of the 60/40 portfolio.
Equities – as inflation rose from 1966 to 1974, the US cyclically-adjusted price/earnings (CAPE) ratio fell from 24x to 8x, according to the Financial Times. Rising inflation means the discount rate used to calculate companies’ future earnings also rises. This would be a calamity for highly-rated growth stocks and profitless businesses.
Infrastructure – these investments are the protection of choice for many, and are essentially disguised bonds or equities with inflation-linked revenues. At risk from a derating of equities or bonds, with added illiquidity and execution risk. Most infrastructure projects rely on governments to pay inflation – and governments have a habit of changing the terms of trade.
Commodities – these will perform as long as inflation is accompanied by strong economic growth. This could happen as we recover from the pandemic.
Gold – deserves a place in any diversified portfolio.
Inflation-linked bonds – missing from too many lists of inflation protections due to their relatively-recent genesis, meaning they haven’t yet been tested by high inflation. If inflation returns, investors could find this is exactly the asset they need.
A bit of inflation is the answer to many central bank and government prayers, but the tailwind of easy policy and falling unemployment may lead people to expect higher inflation, and in due course to get it. Charity trustees should think about how to protect their portfolio against this scenario.
Edward Donati is an investment manager at Ruffer
Ruffer LLP is a limited liability partnership, registered in England with registered number OC305288 authorised and regulated by the Financial Conduct Authority. The information contained in this article does not constitute investment advice or research and should not be used as the basis of any investment decision.
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