Many equity fund managers are now repositioning their portfolios to take advantage of sectors that are likely to hold up well in an inflationary environment.
And while not all fund managers agree on the best place to invest, a number of themes are emerging where there is unanimity. Utilities, tobacco and infrastructure, for example, figure highly on many fund managers’ lists.
Infrastructure funds have two main advantages in times of inflation. First, they have predictable cash flows as they tend to have long- term contracts in areas such as water companies and oil distribution pipelines.
Second, they have holdings such as toll roads, port authorities and airports, which are able to pass on price increases to consumers.
Tony Lanning, head of multimanager at Gartmore, who has just bought a position in a global infrastructure fund, says: “If you use a toll road to get to work, you’re not suddenly going to stop using it if prices go up.”
In general, fund managers agree that investing in price setters rather than price takers in times of high inflation is a good strategy as those with more control over prices are better able to pass on cost rises to the consumer.
Martin Cholwill, manager of the Royal London Equity Income Trust, says: “Be wary of companies that lack pricing power. Their margins may have to absorb some of the inflationary pressures from rising input costs.”
Food producers fall into this category, he believes, as it may take them some time to recover their increasing costs because of the power of food retailers.
But there is some disagreement over the wisdom of investing in food retailers, as, on one hand, they can pass on costs, but on the other they may be hit by a slowdown in consumer spending. Those in favour include Aruna Karunathilake, manager of Fidelity’s UK Aggressive fund, while those against include Graham Wood, chief investment officer of equities at SWIP.
High-street clothing stores are likely to be hit by inflation, fund managers agree, as many source from emerging markets such as China, where goods are based in dollars.
Low-cost retailers will be particularly damaged, says Karunathilake, as they cannot pass on the costs to consumers. He has been reducing his exposure in this area since the middle of last year.
But rising costs will hit these retailers later in the year. Because they are forward buying, pressures will probably start to be felt in the autumn, Cholwill says.
Luxury goods are less likely to be affected, notes Marcel Porcheron, a research analyst at Bestinvest, as they have strong brands and are able to pass prices on.
Another good example of price setting is seen in the tobacco sector. Both Cholwill and Karunathilake are keen on this area. They argue that when government duties on tax increase, tobacco companies can increase the price by a further 1p – not much for the consumer, but a big benefit for them.
Cholwill adds: “People that continue to smoke aren’t necessarily that price sensitive otherwise they’d have given up a while ago, given the focus on health these days.”
An unusual area Cholwill is keen on is the laundry sector. One of the largest companies in this area, Brooks, which had considerable pricing power, went bust last year. This has brought in more price discipline to the market, allowing other companies, such as Davis Service Group, to dictate prices.
But there is concern in some quarters that tried and tested methods of investing in an inflationary environment may not work this time, because of the unusual economic conditions. Wood at SWIP, says: “It’s quite a complex situation.”
Traditionally, he says, fund managers would be overweight in utilities, food retailers and property, while being underweight in banks and manufacturers with little pricing power.
Banks, though, have been hit by the credit crunch, meaning borrowing is already more expensive than it would normally be when a market starts to slow.
Wood believes interest rates are too high because of the Monetary Policy Committee’s fear of short-term inflation, which means food retailers are off his list – and property too, owing to lack of tenant demand.
In contrast, some manufacturers are doing quite well given the weakness of sterling. “Playing the oil price is one of the few relatively straightforward plays as we see it,” he notes.
Of course, not everyone agrees that inflation is a long-term concern. While Lanning and Cholwill say they are nervous about the UK economy, Martin Walker, UK equities fund manager at Invesco Perpetual, says: “My view is that the inflation is driven primarily by food and fuel and could end up being quite transitory.”
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