Inflation: A growing threat to wealth

The former US president, Ronald Reagan, once described inflation as being “as violent as a mugger, as frightening as an armed robber and as deadly as a hit man”. He was speaking just after taking office in 1980, when inflation in the US would peak at 15%.

While the UK isn’t quite there yet, the rate of inflation has hit a 40-year high of 10.1%. It’s the highest rate in the G7, which some experts believe will remain the case into 2023 and 2024. Energy prices are the biggest contributor to the country’s current inflation rates, but global food prices are also going up. One food industry boss warned the latter could rise by up to 15% this year.

Sadly it’s something few of us have control over. Inflation is calculated using the consumer prices index (CPI) and retail prices index (RPI), which track the increase of price over time. The Bank of England can take corrective measures – raising interest rates to incentivise people from spending. The bank rate currently stands at 1.75%, up from just 0.1% in December 2021, and is reviewed every six weeks.

In a YouGov survey, high-net-worth individuals said they see inflation as the second biggest threat to wealth (25%), second only to market volatility (31%). Tax rises was the third threat at 20%. But is there anything that investors can do to protect their money?

How does inflation affect investment?

The relationship between inflation and equity prices is not straightforward. Inflation is capable of chipping away at the value of interest and dividend payments, and eroding the value of capital. It may also result in some asset classes underperforming.

But the impact of inflation on an investment portfolio really depends on where the money is invested, and the period of time inflation is sustained for.  Some experts argue that those invested for the long term shouldn’t allow short-term economic conditions to change their investment strategy too much beyond small tweaks here and there.

What are some of the best investments during high inflation?

Very high inflation tends to have a negative impact on financial assets such as stocks and bonds. Liquid assets are more vulnerable because they appreciate less over time. Similarly, those investments that pay out a fixed income are less appealing because the dividend will be worth less.

In comparison, research suggests that value stocks (or illiquid assets) are preferred by investors when inflation is high. They can have a higher intrinsic value than their current trading price. These could be tangible assets such as art, wine and antiques, private markets such as venture capital and property, or stocks with international earnings.

Research by Connection Capital has found more than two thirds of high net worth investors now dedicate more than 10% of their portfolios to alternative assets, with 30% planning to increase that percentage.

There is no golden rule. But above all, maintaining a diverse portfolio that includes assets that can perform during periods of high inflation can help investors cushion portfolios against unexpected spikes.

How can investors protect their investments from inflation in 2022?

• Gold
  Historically, gold is often pointed to as a safe haven for wealth during inflation. There is only a limited supply around the world and unlike currencies issued by central banks, you can’t print more and devalue it in the process. It has certainly increased in value in recent decades. In 1999, gold was worth £179.61 per ounce, according to the World Gold Council. It’s now worth more than £1,300 for the same amount.
  
  But gold also divides investor opinion – some experts believe it isn’t always the best option, particularly in the short term when interest rates are rising. It lost value in 2021, and has been very volatile in recent months. It’s considered more of a hedge against uncertainty than inflation itself.

• Fine wine
  In 2018, the world record for the most expensive bottle of wine sold at auction was beaten, when a bottle of 1945 Domaine de la Romanée-Conti sold for $558,000 (£458,000). It’s just one example of the returns fine wine investors are hoping to receive.
  
  Wine has been more likely to maintain its upward trajectory during rising inflation, beyond even gold, although both asset classes benefit from the scarcity factor. In 2021, the Liv-ex 1000 index ended the year up 19.08%, with real returns at 12.23% based on the CPI inflation across G-20 economies .
  
  It’s a pattern that’s played out historically too. In an analysis spanning nearly a century, Man Group and Duke University found wine has a positive real return of 5%. That’s because the primary drivers of wine prices are supply and demand, wine quality and brand prestige – all factors largely untouched by rising inflation.

• Other collectibles
  There are other assets that allow investors to combine their passions with good economic sense. Art and stamps, for example, were also identified by Man Group’s analysis as good inflation hedges over time. Art had a real return of +7%, with stamps at +9%. Whisky also gained 20.62% as a category in 2021. But it’s important to keep in mind that collectibles are not a very liquid asset class so are not recommended for investors looking for quick returns.

  Commodities
  Commodities have historically been a good bet during inflationary periods. When inflation rises, the price of goods increases and so does the price of the commodities used to make those goods. Raw materials such as oil, metals or food sources which are used to create other products may offer some protection against inflationary pressure.

  Renewable energy infrastructure
  The UK and EU are aiming to reduce carbon emissions to net zero by 2050. Renewable energy infrastructure assets such as wind farms and solar energy generators could provide opportunities for companies, funds and investment trusts to capitalise on growing demand. According to The Investment Association, investments made in ESG funds added up to more than £1bn per month in 2020. These assets tend to have relatively high yields and dividend growth is expected to keep pace with or beat inflation.

Can you profit from inflation?

The classic 60/40 portfolio investment strategy can start to lag during periods of high inflation. But those investors that tilt towards commodities and alternative assets, and away from stocks and bonds could see greater returns. While no asset is guaranteed to protect your investment, those real assets such as commodities, infrastructure and luxury items have different price drivers.

“Historically, the wine investment category has been perceived as only for the wealthy, or those with considerable wine knowledge. We know this is not the case. It has become an increasingly popular investment asset among the general public, especially as the low-growth, low-rate yet high-inflation environment has left many investors to seek out alternative investments for better returns and to hedge against inflation.”

Tom Gearing

CEO and founder of CultX

He continued, “As a physical ‘passion asset’, the primary drivers of fine wine prices are internal factors, namely limited supply and persistent demand through different macro backdrops. Wine is therefore less susceptible to changes in inflation or policy than many other financial assets”.

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