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Where should we invest in times of inflation?

29 September 2021
Home country bias

Emilie De Clercq, Portfolio Manager

One of the most discussed topics this year to date has been inflation, and whether it was/is transitory or structural in nature. The answer might be somewhere in the middle, with some driving forces being one-time events linked to the reopening of the economies and the imbalance between supply and demand. Some other reasons however, such as high wages pressures or rising housing costs, might be more permanent.

As a result, we regularly discuss - both with our clients and amongst our team - where to invest in an inflationary environment, and how we can best position portfolios to be protected.

In Fixed Income, inflation will decrease the present value of future coupons and principal, so allocating towards short duration instruments will reduce this impact. Inflation-linked bonds may seem an obvious alternative, but we should first ensure that the expected inflation is enough to make up for the difference between the real yield of the inflation-linked bond and the nominal yield of a “conventional” bond, which might not be the case when inflation is widely expected by market participants.

For Equities, it is important to be selective in the companies you invest in, and to keep some criteria in mind. High dividend paying stocks will tend to underperform the market, as they will behave much like a fixed rate bond. For the same reason, growth stocks (valued by discounting potential future cash flow) are likely to underperform value stocks. Investors should focus instead on companies with “pricing power”, meaning those which are able to pass their rising product costs to the consumer. Subscription-based technology companies are a good example, as they are able to increase their monthly fees without any significant spikes in cancellations. It is also beneficial to favour companies with a limited need to issue debt, as the debt servicing cost will increase with inflation.

Tangible assets, like real estate and commodities, have historically been seen as inflation hedges. Commodity prices will typically rise with inflation, but this is a very volatile asset class and their prices will be impacted by geopolitical or meteorological factors often hard to anticipate. If we examine the case of gold, historical data suggests that it will only maintain its purchasing power over very long periods (a century or more). Over shorter periods, its inflation-adjusted price will fluctuate as much as any other asset class, and it will usually underperform both equities and fixed income. The case for real estate is more appealing, as both the property value and the rental income will rise with inflation. In addition, because of its low correlation to traditional asset classes, it offers diversification within a portfolio.

Whilst it is important to take all of these points into consideration when investing in an inflationary environment, we still believe the focus should be on having a well-balanced and diversified portfolio invested according to each client’s risk profile, and continuing to target good quality companies where we have strong conviction – something at the core of our investment process.

This communication is provided for information purposes only. The information presented herein provides a general update on market conditions and is not intended and should not be construed as an offer, invitation, solicitation or recommendation to buy or sell any specific investment or participate in any investment (or other) strategy. The subject of the communication is not a regulated investment. Past performance is not an indication of future performance and the value of investments and the income derived from them may fluctuate and you may not receive back the amount you originally invest. Although this document has been prepared on the basis of information we believe to be reliable, LGT Vestra LLP and/or its affiliates gives no representation or warranty in relation to the accuracy or completeness of the information presented herein. The information presented herein does not provide sufficient information on which to make an informed investment decision. No liability is accepted whatsoever by LGT Vestra LLP, employees and associated companies for any direct or consequential loss arising from this document.

LGT Vestra LLP, LGT Vestra (Jersey) Limited and LGT Vestra US Limited are affiliated financial services companies (each individually an “Affiliate). LGT Vestra LLP is authorised and regulated by the Financial Conduct Authority in the United Kingdom. LGT Vestra (Jersey) Limited is incorporated in Jersey and is regulated by the Jersey Financial Services Commission. LGT Vestra US Limited is Authorised and Regulated by the Financial Conduct Authority in the United Kingdom, and is a Registered Investment Adviser with the Securities & Exchange Commission in the United States.