Deeper deflation hits portfolios and annuities

Private investors are being advised to protect their portfolios, following the announcement of deepening deflation this week.

The retail price index (RPI) recorded its biggest monthly drop since records began in 1948, falling from -0.4 per cent to -1.2 per cent in April, due in part to lower mortgage costs.

The consumer price index (CPI) also fell from 2.9 per cent in March to 2.3 per cent in April, according to the Office of National Statistics.

Ongoing RPI deflation will hit pensioners who have bought inflation-linked annuities.

Standard Life has already written to its 25,000 customers with RPI-linked annuities to warn them that their income is set to fall, and similar annuities from Prudential will also pay out less.

Many index-linked annuities, however, have a built-in “floor”, for which customers pay a premium, to ensure that pension income will not fall below a given level.

Norwich Union, L&G and Axa are not expected to lower the income they pay to pensioners on their index-linked annuities.

But in spite of this week’s data, some advisers warn that inflation could return sooner than expected. Hargreaves Lansdown said pensioners should still inflation-proof their pension incomes by buying these index-linked annuities.

“A pension contract is for such a long period of time you can almost be certain inflation will be a problem at some stage,” said Hargreaves’ pension adviser, Laith Khalaf.

The twin fears of current deflation and looming inflation are also putting discretionary portfolio managers in a difficult position.

“If I was an investor now, the biggest concern I would have is that I have no idea whether I will face deflation or hyperinflation,” admitted Hugh Adlington, head of asset allocation at Rathbones. “The investment policy to deal with both is totally different.”

He said that because it was difficult to take a clear view either way, he is hedging client portfolios against both outcomes.

Investors should take advantage of extreme pricing to move between assets that do well in deflation, and those that do well in inflation, he advised.

“Until you’re sure of what sort of recovery you’re going to get, I don’t think you should be doing much else,” he warned.

Jonathan Blain, a partner at IPS Capital, thought deflation was more priced in to assets than inflation, meaning an inflation scare could cause investors more losses if they held the wrong assets.

Adrian Lowcock, senior investment adviser at Bestinvest, said that what happened with inflation or deflation would be a “decisive factor” in determining how investors construct their portfolios over the next few years.

“I would suggest investors should not take drastic action to balance their portfolios for one scenario over another,” he said. “Getting it wrong either way could be equally damaging to their portfolios.”