The investment trust sectors that could protect you from high inflation
David Prosser proposes some investment strategies to consider for those worried about the rising cost of living.
How high will inflation go? While it’s hard to keep track of the twists and turns of the Iran conflict, the International Monetary Fund has warned in recent days that war in the Middle East could push inflation in the UK as high as 4% this year, as the impacts of higher oil and gas prices spread. In some areas of household spending, the spike could be far more dramatic: Cornwall Insight, a consultancy, thinks the energy price cap may increase by 20% in July.
We shouldn’t panic. While a 4% peak would still be twice as high as the rate that the Bank of England’s Monetary Policy Committee is aiming for, it’s miles off the 11.1% inflation high seen following Russia’s invasion of Ukraine in 2022. And some commentators are more optimistic – the Bank of England itself, for example, has suggested 3.5% is possible.
In many cases, infrastructure investments offer inflation-linked contracts, ensuring investors’ returns keep pace with price rises.
David Prosser
Still, we do now appear set for a period of higher-than-expected inflation that erodes households’ purchasing power. The Bank’s Governor points out that steps such as raising interest rates, the MPC’s usual anti-inflation measure, will do little to counter the supply-side shock from war in the Middle East. There’s also the risk of inflation going much higher if the war endures – and the current ceasefire remains shaky.
Given all of this, how might investors protect themselves against the threat they now face? And which investment trusts might help?
The good news is there are three credible ways in which investment trusts could provide some insulation from price rises in the months and years to come. Even better, these options are all quite different, enabling investors to secure diversification benefits too.
Option one is a Global or UK Equity Income fund. Many investment trusts in these sectors prioritise the generation of consistent income as well as seeking to deliver capital growth. To get that consistency, they seek out companies in strong competitive positions in their markets. These are the businesses that will be able to raise prices when their own costs increase; this protects their value and ensures they can maintain or even increase dividend payouts.
Equity income funds won’t always look for the highest yielding shares; rather, they favour companies that generate reliable and sustainable dividends. This is especially valuable in a tough trading environment. The income from these funds becomes an important part of your total return, offsetting the impact of inflation, but you also retain exposure to assets with the potential to deliver long-term capital growth.
Option two is one of the investment trusts in the Commodities and Natural Resources sector. These are funds that directly benefit from rising raw materials prices – including higher energy prices but also increases in the cost of natural resources. These funds either invest in those commodities directly, or in the shares of the businesses that extract them, from miners to oil producers.
It’s also possible to use commodities funds to get exposure to gold, often seen as a useful hedge against inflation because it provides an intrinsic store of value. That said, gold prices had hit record highs even before the US and Israel went to war with Iran; that trend may have run its course according to some analysts.
The third possibility is an investment trust that focuses on real assets – in particular, physical infrastructure. That could be anything from transport networks to the digital plumbing needed for the artificial intelligence revolution.
In many cases, infrastructure investments offer inflation-linked contracts, ensuring investors’ returns keep pace with price rises. But even without such guarantees, the huge demand for these assets is compelling.
In addition to the broad-based Infrastructure grouping, the investment trust industry also offers a Renewable Energy Infrastructure sector. These funds, which are helping to build the networks required to transition from fossil fuels to clean energy, look particularly interesting when the cost of oil and gas has risen so sharply. Soaring fossil fuel costs only amplify the imperatives for moving towards renewables.
Finally, it’s worth pointing out that while some open-ended funds also offer exposure to these three potentially inflation-busting asset classes, investment trusts have particular advantages.
Investment trusts are unique among collective funds in having an ability to build up dividend reserves. By holding back some of the income they earn during bumper periods for company distributions, investment trusts can boost their dividends during leaner times. This enabled many investment trusts to continue to raise their payouts during the Covid crisis and following Russia’s invasion of Ukraine.
On commodities and infrastructure, meanwhile, it’s important to recognise that these assets are often illiquid – they’re harder to trade than shares listed on public stock markets, and certainly harder to trade quickly. That can cause issues for open-ended funds, which are constantly managing inflows and outflows of money as investors buy and sell. The structure of an investment trust – a closed-ended fund to which investors get exposure by buying its shares – has clear advantages in this regard.
David Prosser
David is former Business Editor of The Independent, Personal Finance Editor of the Daily Express, and Deputy Editor of Money Observer magazine. He writes regularly for the AIC.
