Shielded: Buyers of Burberry are less likely to be hit by inflation
Inflation in the UK is heading towards seven per cent – and we’ll know how far we are down the road towards that figure on Wednesday when the Office for National Statistics produces the number for February. Five per cent? Maybe. Could even be a tad more.
While inflation is bad news for both households and most businesses, usually doing untold damage to their respective finances and profits, it is not necessarily a negative for investors.
Some stock market-listed companies are more resilient than others when it comes to fending off the adverse impact – and it is reflected in their buoyant share prices.
As far as investors are concerned, it is finding these investment gems that is the hard part.
David Coombs, a fund manager with investment house Rathbones, spends most of his working day trying to identify such gems. He admits he is obsessed about inflation.
He runs a £1.6billion multi-asset fund called Rathbone Strategic Growth Portfolio, the aim of which is to deliver investors annual returns three per cent ahead of UK inflation.
It’s an objective that the fund is meeting. During 2021, it generated a return just short of 12 per cent, compared to its inflation plus three per cent benchmark of 8.3 per cent.
Over the past five years, the return is 44.7 per cent against a benchmark figure of 30.9 per cent.
But achieving this investment objective is not without its challenges. The fund has a third of its holdings in relatively stable assets such as government and corporate bonds, some such as US Treasury Tips (Treasury Inflation-Protected Securities) providing in-built inflation protection.
But the key to generating inflation-beating investment returns, says Coombs, lies in finding companies that will flourish despite inflationary headwinds. Most, not all, are to be found outside the UK.
‘Inflation has a big impact on people’s purchasing decisions.’ says Coombs. ‘A 10 per cent price rise on a film subscription service that previously cost £8 a month will be tolerable for many households – just an extra 80p a month to find.
‘But if the price of a new washing machine goes up by 10 per cent from £400 to £440, that £40 price increase could well deter many households from buying it. It’s why we hold shares in Netflix – it has a strong dose of price resilience built into its customer base. We almost look upon it as a new-style utility company.’
Other companies that Coombs likes because their business models have an element of inflation proofing built into them include US computer software company Adobe and computer games businesses Electronic Arts (US based) and Ubisoft, headquartered in France.
He also believes shares in banks offer investors good inflation protection because of banks’ ability to increase profit margins (the difference between what they charge borrowers and pay savers) when interest rates are rising.
Luxury brand companies – such as LVMH, Ferrari and Burberry – have resilience, says Coombs, because their customers have the wealth to combat inflation.
It’s a point also made by Laith Khalaf, head of investment analysis at investment platform AJ Bell. ‘If you’re willing to shell out £2,000 for a Burberry trench coat, chances are you’re in a wealth bracket where inflation is a dim and distant problem,’ he says.
‘Burberry’s customer base should therefore remain resilient in the face of rising prices, while greater socialising and travel in the post-pandemic era should increase demand for its products, as well as footfall through its physical stores.’
Burberry’s shares are up by six per cent this year, compared to a 0.3 per cent fall in the FTSE All-Share Index. Paul Allison, head of equity research at share trading platform Freetrade, says pricing power is key for companies in an inflationary environment.
He says: ‘Pricing power exists when companies are able to raise their prices irrespective of the economic backdrop. Usually, it’s because they benefit from what legendary investor Warren Buffett describes as a moat – some form of barrier to entry that gives them a competitive advantage over rivals.’
Among those companies are US drinks manufacturer Coca-Cola and UK telecoms company BT. Allison says: ‘Coca-Cola’s strength lies in its powerful brands. It enjoys customer loyalty and is able to raise prices without any meaningful drop off in demand.’
As for BT, he says many of its key products such as broadband and landline phones have an element of inflation linked into their prices.
Richard Hunter, head of markets at wealth platform Interactive Investor, says drinks giant Diageo has similar pricing power, especially in the growing Asian market where the region’s emerging middle classes are increasingly drawn to premium brands – the likes of Talisker and Johnnie Walker whisky – irrespective of price.
He says the nine per cent share price fall since the turn of the year ‘could provide an attractive entry point for new investors,’ adding: ‘Diageo has 200 brands that are sold in more than 180 countries. So it’s a well diversified business by both brand and geography.’
Freetrade’s Allison believes profitable technology stocks should also not be discounted by investors. ‘Microsoft’s business model is based on saving its customers money,’ he says.
‘Satya Nadella, its chief executive, recently said that digital technology is a deflationary force in an inflationary economy. He’s spot-on. Its products save customers money. On that basis, it should be able to protect its profit margins without needing to raise prices.’
Rathbones’ Coombs agrees albeit for different reasons. He argues inflationary pressures will wane in the second half of the year. As this happens, he will look to increase his exposure to well financed technology firms such as Microsoft as well as Alphabet and Amazon.
How 36 trusts stayed ahead of rising prices
Some investment trusts, usually investing in a basket of shares, have a proud record of growing their share price and dividends by more than UK inflation.
Research conducted by the Association of Investment Companies has identified 36 such stock market-listed investment trusts.
All of them have generated both dividend growth and share price returns in excess of 2.5 per cent per annum over the past five years – 2.5 per cent being the average annual inflation rate as measured by the Consumer Prices Index.
The list includes the likes of Merchants and Witan, trusts that have long histories of annual dividend growth going back 39 and 47 years respectively.
But it also features some surprises such as Templeton Emerging Markets, Montanaro UK Smaller Companies and Fidelity Special Values that many investors tend to view as more growth-orientated trusts – rather than providing a blend of inflation-beating income growth and share price return.
Among the 36 are also specialist trusts with an investment emphasis on renewable energy (Greencoat UK Wind), private equity (Apax Global Alpha) and property (Tritax Big Box). Annabel Brodie-Smith, communications director at the AIC, says it’s ‘encouraging’ to see such a variety of inflation-beating trusts included in the list.
But she warns there is no guarantee that such performance can be repeated over the next five years. ‘Investors should do their own research and, if in doubt, consult a financial adviser,’ she says.
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