Adrian Lowcock, investment director at Architas, commented, ‘Investors haven’t had to worry about inflation for a long while. But in 2017 inflation has returned with the Bank of England forecasting inflation will peak at 2.8 per cent by 2018. The return of inflation is widely expected by the market as the recovery in the oil price and the fall in the pound following the EU referendum are likely to drive prices higher. As such traditional inflation proofing assets such as Index Linked Gilts, have already priced in much of the anticipated rise in inflation. Alternative income assets, such as infrastructure, tends to respond more slowly as investors look to these sectors last.’
The fund he favours to capture this theme is John Laing Infrastructure.
He commented, ‘This fund invests directly in the equity of a globally diverse range of PFI projects. For example it owns a 35 year concession to operate and maintain 23 service stations in Connecticut. The assets have leases with McDonalds (30 years), Mobil, Subway and Dunkin Donuts (15 years each). This is a defensive fund and has a diversified portfolio which should pay a predictable, inflation-protected yield. Investors should expect steady, low-risk income with some small potential for capital growth.’
He continued, ‘The fund currently provides a dividend yield of 5.2 per cent and has grown its dividend by an average of 2.2 per cent per annum over the past 5 years.
Russ Mould, investment director at Architas commented, ‘“On the stock front, companies that are able to consistently grow their dividend payments can also provide a natural buffer against rising inflation.’
The find he chose is Artemis Income. He said, ‘This fund has been one of the most consistent funds in the equity income sector over the past decade with experienced fund manager Adrian Frost expertly navigating almost everything markets have thrown at him over this period.’
The analyst added, ‘The fund is well diversified and looks to produce a rising income ensuring that it focuses on companies that offer dividend growth rather than just an outright high yield which helps offset the impact of rising inflation. That said the current yield of 4.2 per cent looks attractive with the manager finding opportunities in larger UK companies such as BP (BP.) and GlaxoSmithKline (GSK). Over the years, the manager has also shown skill in finding opportunities in mid and small companies and occasionally looks overseas should attractive opportunities become apparent.’
In the long-term, the best response to inflation is to target companies which have pricing power.
He added, ‘If a firm can charge what it wants to charge it should generate high margins, consistent earnings and robust cash flow, which it can then turn into the reliable and growing dividends which provide such a large percentage of long-term total shareholder returns, especially once they are reinvested.
‘By contrast, firms without pricing power – such as producers of commodities like paper, pulp or steel – tend to churn out more volatile earnings and more volatile dividends. As a result, their stocks also tend to enjoy lower long-term trend valuations than those firms with pricing power and the ability to provide consistent returns.
‘Firms with pricing power are the type sought by those funds whose style could perhaps best be described as “quality growth” – they could underperform short term but in the long run class could still tell as they target steady long-term returns via both capital growth and income.’