Inflation Is Up, Is This An Issue?

We believe that, ultimately, it’s imperative to move the debate forward with respect to what constitutes ‘risk’ to an investor. Thinking of risk purely in terms of volatility is a disservice for investors as in reality ‘risk’ is so much more than a number. One of the greatest risks that many savers are taking – often unwittingly – is the risk of having insufficient funds for a reasonable lifestyle at retirement, especially when the ravages of inflation are taken into account.While inflation may only be of moderate interest to today’s investors, looking to the future, it’s going to be a pivotal concern for tomorrow’s pensioners. The good news is that, with sufficient time horizons, all assets have historically beaten inflation. It may be difficult to believe but this also includes cash in the UK. The real difficulty in beating inflation time series is that they are relentless; inflation is almost always positive, especially in the UK. As a result, a cumulating inflation time series nearly always goes up in a straight line, unlike investable assets which have price volatility in the form of mark to market moves.
As we know some asset classes have high price volatility whereas others are relatively low. Investing to beat inflation is difficult because of the mismatch in volatility between these different assets and the low volatility nature of inflation. As a result, you shouldn’t expect to beat inflation with a month or even a year’s returns – it requires a reasonable time horizon.
The best way to reduce the volatility around the stable inflation returns series is to create diversified portfolios that have a genuine suite of differentiated returns drivers contained within them. To enable this, it may be necessary to hold some assets that you do not expect to beat inflation over the medium-term but that are instead a decent stabiliser. There may be times where few asset classes display the necessary expected real return. This is a time for discipline to be applied. It would be all too easy to dominate a portfolio with the few attractively valued asset classes, but doing so would be unlikely to provide a suitable balance of risks to investors.
It is this propensity of investments to move in price that in the end helps us – these moves bring with them the potential for an asset class’ valuation to deviate from fair value and the opportunity set for investors trying to beat inflation comes from a valuation focus. Other tools at our disposal that help improve the profile of returns include making use of a global range of asset classes and sub-asset classes. It’s imperative to be able to identify opportunities with finesse whether that be in regional or sectoral equity markets or even a particular part of the interest rate or credit curve. Within equity markets, it’s also important to make use of style factors, as this is a very effective way of using highly volatile returns streams that each have a unique stylistic tailwind to create a selection where the combination is far greater than the sum of the parts in terms of risk adjusted returns. Improving risk- adjusted returns through means such as these is an effective method to enhance the probability of achieving the desired return in excess of inflation.

Click here to learn more about the benefits of a diversified portfolio, and specifically the advantages of a low cost, bespoke, discretionary portfolio over a model portfolio.


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