Taking the fight to inflation

How many funds are delivering positive returns in real terms during this ongoing period of inflation? That shouldn’t be too much to ask, but with inflation remaining stubbornly high – even if it has fallen from a peak of above 11% – it is not as straightforward as investors might hope. You’re going to need to think about where that performance is going to come from.

Fascinating new research from Interactive Investor underlines that point. The investment platform looked at the track record, versus inflation, of the 19 investment companies that the Association of Investment Companies classifies as its “dividend heroes”. Remember, these are the funds that have increased their dividend in every single one of the past 20 years.

The period considered ran for five years to the end of May, so it included years in which inflation was very low as well as the past couple of years, when price rises have spiked so much higher. Over that entire period, inflation totalled 21.9% – that is, a basket of goods that cost £100 on day one cost £121.90 after five years – so this was the figure that the funds had to beat.

There are a few ways to judge the dividend heroes. First, Interactive Investor looked at how dividends specifically had risen – it found that seven of the 19 funds had delivered total dividend growth that outstripped inflation. In other words, the dividends investors have received over the past 12 months were more valuable, in real terms, than the dividends they received in year one of the five years. These dividend heroes not only increased their dividends every year, but also, over five years, their increases more than compensated for inflation.

What about capital performance though? Here, Interactive Investor looked at the growth of the fund’s net asset value, where it found 10 of the Dividend Heroes had managed to beat inflation over five years. The fund’s underlying investments were worth more in real terms at the end of the period than at the beginning. At nine of these ten funds, that performance translated into a positive real terms share price performance.

Pulling these numbers together, Interactive Investor found that three of the 19 dividend heroes had delivered both dividend growth and share prices gains that outstripped inflation. The funds in question were Alliance Trust, Caledonia Investments and F&C Investment Trust.

What does this exercise tell us? Well, the first point to make is that with inflation so high, it has proved very difficult, even for the best funds, to deliver inflation-beating income and capital returns. It’s not so difficult to find a fund that will give you an income that rises ahead of inflation over the long term; similarly, many funds have the potential to grow your capital in real terms. Finding funds that do both, however, is challenging.

For investors, this means thinking hard about your objectives. If you’re living off your investment income – in retirement, say – your priority may be to ensure that income keeps pace with inflation. If you’re focused on building up a lump sum over time – possibly even reinvesting your dividends – it may be preservation of the real value of your capital that is your absolute focus.

Either way, high levels of inflation are challenging for all funds – even the dividend heroes with their outstanding track record. Think carefully about whether your fund is capable of delivering on your imperatives. You need a fund that has objectives aligned to your own financial planning needs.