No matter where you are in your professional life, inflation is a common worry, especially when we are seeing the cost of living reach levels we have not seen in decades. Inflation is something that happens regularly and is natural to the economic cycle, but with rates rising at the fastest pace in nearly 20 years, this opens up the big question: how can you protect your assets and thrive in this challenging financial climate?

This blog will cover topics around the current inflation rate, its causes and potential challenges for investors, the sectors to consider and avoid when inflation is particularly high, and how to get involved in worthwhile investments to help protect wealth.

What is the current inflation rate?

We’re experiencing times of great uncertainty as prices all-around hit record highs. In the UK, house prices are now at their highest since 2005, food and energy bills have been already been rising over the last several months, and with the new VAT increase from 1^st April, hospitality businesses are also upping their prices, leaving Britons facing further steep costs, now in pubs and restaurants.   

On top of this, the Office of National Statistics reports the below Consumer Price Index performance over the last 10 years, with a 6.2% rise over the last year.

Why has inflation gone up?

The Covid-19 outbreak is one of the key factors which contributes to the current inflation rates as the economy attempts to recover from two years of muted demand across many markets. In recent months, this has intensified following the invasion of Ukraine, which initially caused a surge in oil prices. On the plus side, the cost of petrol seems to have stabilised, but the reality is that the new fiscal year as well as October 2022, which is expected to bring further price increases, will be a difficult time for many.

According to the Bank of England, the light at the end of the tunnel is that the inflation rate will “fall considerably”, with the target being 2% in the next 2 to 3 years. So, as we work towards a healthier financial position, what options are there to help protect your wealth, and what are some suitable asset classes to invest in in the meantime?

Investment planning management

To help protect your finances against inflation, a good place to start is to consider some management strategies when evaluating how best to use your money. As inflation changes, your financial circumstances can change, too, so it’s useful to go back to the drawing board and make sure that you’re well-adjusted to those fluctuations. Some of these techniques can include:

·        Re-evaluate your budget

Everything stems from your budget and financial capabilities. When inflation is particularly high, the extent of how far your budget can go may change, so revisiting that starting point could give you a better idea of what types of investments are better suited to your new circumstances.

·        Revisit your financial goals

As prices rise and your budget changes, it’s useful to consider how this will affect your original financial goals and what you need to do to adapt them. Short-term goals can be more manageable than long-term planning, particularly when time is critical. Inflation is time-sensitive, so it could be useful to adjust your goals to be controllable by splitting those long-term aims into a series of shorter ones.

·        Try an investment calculator

It sounds simple, but an online investment calculator is a quick and easy way of visualising your investment intentions. It will take into account your time horizon, budget, monthly affordability, and risk level, and give you an idea of a potential investment value under different market conditions.

·        Diversify

Portfolio diversification is always an investment technique worth considering as its primary aim is to protect assets from volatility caused by events such as inflation or market crashes. Researching the correlation between different asset classes and understanding how they will react to market changes in relation to one another can help with making sure that your portfolio is well balanced to keep overall damage to a minimum.

Which sectors are sensitive to high inflation?

Inflation will act differently on various sectors, and some will be more vulnerable than others to inflationary pressures. It’s important to remember that sensitivity comes down to a series of additional factors outside of just interest rates themselves, such as geographical location and consumer demand for particular goods or services, and there will be winners and losers in every market.

Generally, some sectors which can be sensitive to high inflation include:

·        Cash savings

Buying power can be reduced with cash savings accounts as their interest can fall below the rate of inflation, meaning that the value of your savings is reduced. While savings accounts do have their benefits and some are index-linked, they can become more expensive when inflation is high.

To put this into perspective, HSBC provides the following example of the effects of inflation on savings:

Let’s say inflation averages 3% over the next 5 years. That means what cost you £1,000 today would cost you £1,159.27 in 2026.

If you put £1,000 in a savings account today paying 0.5% interest, you’ll only earn £25.25 interest over the same period. So you’d effectively lose £134.02.

·        Long-term treasury bonds

Long-term treasury bonds and gilts can be more vulnerable to rising rates as their value can fall with inflation, and their extended duration means they are susceptible to further rate fluctuation. This isn’t guaranteed but being further away from bond maturity can increase the probability that interest rates will continue to rise, causing bond prices to decrease.

According to the Bank of England, the UK 10-year GILT yield reached record-low levels of just 0.25% against an interest rate of 0.10% at the end of 2020. Since the financial crisis in 2008, long-term bond yields have maintained a downward trend despite some momentary encouraging behaviour, leaving a reduced returns potential for investors.

On a global scale, the bond market is now experiencing one of 3 record lows since 2000, as per the below graph.

·        Growth investing

Growth investing refers to high valuation stocks. They are often based on future performance, which can be unpredictable, and tend to be costly. These types of stocks are typically in emerging industries such as tech, and investors make predictions on their performance and valuation to come. While the risk versus reward can sometimes pay off with such stocks, it can be a particularly volatile strategy to attempt during an uncertain economic position.

Taking the US stock market as an example, it has been found that value stocks have outperformed growth stocks by an average of 4.1% annually since 1927 in terms of difference of return. But the ultimate decision will predominantly come down to your attitude to risk. Value stocks (or ‘bargain’ stocks) are generally seen as a more sensible investment choice, so during unstable financial times, they could be a practical choice if you’re looking for reduced volatility.

Which sectors do well in times of high inflation?

High inflation isn’t always bad news for investors. Some sectors have historically performed well as inflation hedges, and some can retain purchasing power and thrive with inflation. Many of these sectors include those that are consumer-centric, meaning that demand remains high for certain goods and services so, when prices increase, so do their stocks.

Below are a few investment sectors that could present opportunities in times of high inflation and even benefit from it:

·        Real Estate

Real estate is often a popular choice among investors, real estate can offer increasing asset value during inflation, which can be useful if you’re thinking about selling. Another advantage is that mortgage rates are typically fixed, so while rent costs rise with consumer prices, the prospect of increased rental income could be particularly useful for landlords.

Considering the below past performance of rental income against inflation in the UK, there have been several periods where rental income surpassed inflation rates.

Looking ahead, industry experts predict an 8% increase in rental income this year to make up for the lengthy period of unpaid rent among retail and leisure businesses caused by lockdowns during the pandemic.

But owning a physical property isn’t suitable for everyone. You could consider Real Estate Investment Trusts (REITs) to invest in the real estate market indirectly and not own and manage property yourself.

However, rental income isn’t the only factor to consider when investing in property. It’s also important to note that some landlords are just as subject to growing prices as consumers are. As inflation goes up, the cost of trade services such as plumbing or decorating may find landlords with higher bills to pay to maintain their property to a satisfactory level. Landlords with small property portfolios and tight margins may start to feel the pinch as they are less able to spread costs and mitigate higher prices.

·        Energy

Investing in energy stocks is often a form of safe haven among investors. Similar to consumer staples, the value of energy stocks tends to rise with consumer demand as prices increase, making this a sector that can benefit from high inflation and offer a possible inflation hedge.

The below graph maps the UK Energy Index between 2007 and 2022.

In a recovering economy, it’s encouraging to see the above data reflect the current Energy Index almost meeting pre-pandemic levels.  

·        Consumer staples

Similar to the energy sector, consumer staples perform alongside consumer demand. This sector includes everyday goods and services such as food, clothing, and personal products that will remain a general necessity. So, as prices for these items increase, the value of the stocks tends to follow.

Industry experts forecast earnings in this sector as a whole to grow by 11% year on year. On a sub-industry level, investors are showing optimism towards beverages, where an annual growth of nearly 9% is predicted.

·        Short-term bonds

The advantage of this investment against inflation comes down to duration. Unlike long-term, short-term bonds allow for quicker access to your funds and can be less sensitive to fluctuating interest rates as they are closer to maturity, meaning fewer coupon payments and less opportunity to react to any further changes to inflation.

The below graph displays the US Treasury and UK Gilt yield curves based on duration against rate increases.

A steep turn can be seen for sub-4 years in the US and sub-2 years in the UK, after which performance starts to fall flat as volatility of the extra duration is added on. With this in mind, short-term bonds of 2-4 years could be a possible inflation hedge over bonds with longer term times.

An inflation hedge: asset-backed bonds

When inflation is high, security is a priority among investors. If you’ve concluded that short-term bonds may be a suitable inflation hedge for you, there is an added benefit of protection with asset-backed bonds.

Asset-backed bonds are loan-based investment vehicles, which are securitised against income-generating assets such as property. A company that issues asset-backed bonds will typically pool together funds from all contributing investors to fund a project or series of securitised projects.

Attractive yields are one of the key benefits of asset-backed bonds. They usually receive a high investment grading and offer fixed rate returns, providing high yield potential and increased stability over other bond types.

Asset-backed bonds are also a useful and convenient way of diversifying your portfolio without having to make multiple investments as the assets behind the bonds can span across various asset classes and geographical locations.

Summary

·        In the UK, inflation is currently at a 17-year high and is expected to stabilise at around 2% within the next couple of years.

·        When inflation is high, there are a few financial management tactics to consider in order to protect your wealth, such as re-evaluating your budget, adapting your goals and time horizon, and diversifying your portfolio.

·        Sectors such as cash savings accounts, long-term bonds, and growth stocks could be more sensitive than other investment methods towards inflation.

·        Sectors such as real estate, energy, and short-term bonds could be more suitable vehicles to consider in times of high inflation.

·         Asset-backed bonds can offer security and stability against inflation, as well as high yield potential and diversification opportunities, all of which can help investors hedge against rising inflation rates.  

How to get involved in asset-backed bonds

At Propiteer Capital, we offer sophisticated investors a selection of asset-backed listed bonds with short term times ranging between 12 and 36 months and fixed-rate returns of 4.5-9.5% pa. Investments help fund a variety of thriving real estate projects within the UK and Ireland. These projects cover the following asset classes and benefits:

Residential Rentals

·        Renting of completed buy-to-let apartments

·        Popular locations in transient cities

·        Purpose-built quality living units

·        Acquisition decisions based on rental income

·        Recession-resilient asset class

Branded Hotels

·        Occupancy delivered from Hilton and Marriott booking engines with 230 million members combined

·        High-demand locations

·        Up to 20 years’ regional exclusivity per hotel

·        Ultra-efficient ‘focused service’ models for higher profits

·        Both hotel brands have 7 ‘focused service’ sub-brands to help target each geographical region

Development Property

·        Build-to-sell projects completed and sold to release development profits

·        Cover UK’s most robust locations

·        A Private Rental Scheme running in Dublin, Europe’s fastest growing economy with unit values based on rent

·        Robust against inflation via quality properties within the London halo effect and high demand growth regions

·        Private rental schemes valued on high yields and become more popular during recessions

With a range of locations and property types, we offer diversification potential for property investors while ensuring profitability and returns.

To find out more about us and our flexible fixed-rate returns, visit our website.

Rates are accurate at the date of publishing. For our latest rates, please visit our homepage.

Recommended Read: Should I Buy Property or Invest in the Stock Market?