Inflation is back. But what does that mean for investors?

The Iran conflict has affected many people and many countries and investors have certainly not escaped. Probably the most direct economic impact has been the sharp rise in inflation fueled by a near doubling of oil prices. And while easy to think of higher oil prices as only affecting petrol prices, its impact is far wider than that. Oil is a key input in the production of plastics and a key ingredient for agricultural fertilisers – if the oil price soars, everything goes up.

For investors though, higher inflation matters as it affects both the value of savings and how different types of investments perform. In addition, compared to recent years, this time higher inflation appears a more serious problem. Previously, central banks could raise interest rates to slow economic growth and bring inflation down. But that won’t work today. Current inflation is not being led by overheating economies, but higher oil prices responding to geopolitics, not economic conditions. Add to that interest rates which globally are already at relatively high levels, and attacking inflation using even higher rates risks harming global growth further. Unfortunately, central banks have an unenviable choice – raise rates and risk growth, or don’t, and risk inflation becoming entrenched.

This is creating a challenging environment for investors, particularly those with traditional equity (shares) and bond investments. Fortunately, within these broad asset classes, there are so many different options available, investors can still prosper through careful asset selection. With bonds for example, an asset class that normally underperforms with high inflation – prices fall with investors demanding higher yields to compensate for inflation – options exist. The most obvious are inflation-linked bonds. These are types of bonds where the regular payments made to bond investors rise in-line with rising rates of inflation. This has the effect of protecting the real value of the income received from holding these bonds.

Within equities, appealing options exist, but investors need to be selective with inflation impacting different types of equities in different ways. Equity funds with a high growth bias may suffer as high growth stocks often have high valuations, exposing them to economic downturns which can lower future profits and consequently lower their valuation. However, more defensive companies, such as supermarkets, utilities and providers of essential products and services, are far better protected from inflation. These companies often have strong pricing power with customers often having little choice as to whether to use them. We all need to eat, switch our lights on and use our mobile phones.

A popular choice recently has been infrastructure investments, and these can also be highly appealing in an inflationary environment. Infrastructure companies are typically water or energy utilities, toll roads, rail companies, airports and digital infrastructure providers, such as fibre-optic cables or mobile phone mast providers. These are often heavily regulated businesses providing essential services to businesses and communities, but importantly, with pricing models often directly linked to inflation. When inflation rises, their prices and revenues follow suit.

The prime takeaway for investors is don’t panic! While inflation seems likely to remain high for some time, remember different assets will react in different ways. Even within a particular asset class, there are always options able to provide resilience and positive performance. The key is understanding the choices available, being flexible and ready to select the right opportunities when they come along.

The views expressed on this webpage should not be taken as a recommendation, advice or forecast. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to your financial adviser.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.