Savers given option to outwit inflation

Investors who want to protect their savings against inflation will have another option from next week, when M&G launches the first ever index-linked UK corporate bond fund. This new fund will hold inflation-linked bonds issued by UK companies, with the aim of delivering returns in excess of the consumer price index (CPI) over the medium to long term.

Among its investments will be bonds from National Grid, British Telecom and Tesco, which pay a set interest coupon plus inflation to protect holders against rising prices. Fund manager Jim Leaviss, who is giving up running the M&G High Yield bond fund to launch the new vehicle, explains: “The biggest issuers tend to be utilities because their revenue streams often have a regulatory link to inflation – they can only raise prices in line with a formula linked to RPI, so issuing an inflation-linked bond makes sense. And Tesco literally is the RPI basket, in terms of its revenues.”

In addition, the fund will use floating rate notes – short-term bonds issued by banks and linked to money market rates – as well as government securities and derivatives to keep returns ahead of inflation. It will levy an annual management fee of 1 per cent and have an initial charge of 3 per cent.

Advisers say the use of inflation-linked corporate bonds is a logical step, as few other investments now offer inflation proofing. Index-linked government bonds are no longer effective as demand has pushed their prices up, sending their yields down below the rate of inflation. “Everything of a maturity below 7 years in the inflation-linked gilt market has a negative real yield,” says Willem Sels, head of investment strategy at HSBC Private Bank UK.

Index-linked Savings Certificates were withdrawn by National Savings & Investments in July, and National Counties Building Society closed its inflation-beating individual savings account (Isa) two weeks ago, due to “overwhelming” demand.

Brian Dennehy of independent advisers Dennehy, Weller & Co, therefore welcomes the M&G launch, saying: “It’s rare to get an initiative to add value in client portfolios.”

M&G’s fund will not have many holdings to choose from, notes Sels, as only 8 of the 340 UK inflation-linked bonds are larger than £500m. “It is relatively illiquid, and there’s concentration risk,” he warns. But Dennehy believes the launch of the fund will result in more bonds being issued – as was the case with the High Yield fund in 1998. “M&G might almost create supply by having the fund available,” he says. According to Leaviss, one bank has already contacted M&G to say it is interested in issuing a new inflation-linked bond for the fund.

While inflation remains low, however, advisers do not see the fund as a buy. “Once we see CPI or RPI come down for a couple of months, the market will anticipate much lower inflation – then fixed rate bonds will do well and inflation- linked bonds will not do well,” says Sels.

Dennehy advises a “wait and see” approach as he does not expect inflation to be a risk in the next 12-24 months.

Leaviss believes the fund will offer protection in future, though. “We are building the fire engine for when the fire starts,” he says.