Emma Wall: Hello and welcome to the Morningstar Series "Ask The Expert". I’m Emma Wall and I'm joined today by Edward Fane, from Morningstar Investment Management.
Hi, Ed.
Edward Fane: Hello, Emma.
Wall: So what effect does inflation have on people's investments?
Fane: So, I guess, what is inflation? Inflation is just the fact that over time, the prices you pay for something tend to rise. That maybe because they come from a scarce resource, that continues to be in demand. It might be because businesses manage to find a way to sort of add value to it, but prices tend to rise.
Wall: And it does mean that if inflation is high that those who are running money have a greater benchmark to beat in order to give a real return to investors don't they. For example, in the times of very high inflation and the couple of decades ago 7%, 8% that meant that if you are running money at that time, you really had to be delivering 10, 11, 12 to be giving a real return to your investors?
Fane: That’s absolutely true. You know fundamentally the absolute minimum that any investor as opposed to putting the money under the mattress, should one is that the money they have should be able to buy them the same goods in the future as it can today. So that means at the very least, your money needs to try your investments need to keep pace with that rise in prices, i.e. keep pace with inflation.
Wall: We should probably caveat this with the fact that inflation looks very low at the moment, but since the beginning of the year we have seen oil prices rising. And the reason why inflation is so low at the moment is because prior to that we had 18 months of oil prices falling. So although inflation is low at the moment, this could be the time to start thinking about in the future how you should be investing to protect yourself from the oncoming inflation.
Fane: Absolutely true. So, inflation has a number of elements in it. Your inflation is the change in prices all of basket of goods that you might buy in the course of your life. And a lot of those tend to be more stable, but there are specific elements and they tend to be your energy costs and also perhaps food that are much more cyclical. So there is a lot more noise in them.
If there is bad harvest globally, then actually that can cause food prices to rise and we’ve seen oil prices really fall significantly over the course of last year. And actually recover to an extent this year. What that means it’s just that technical point where the very low prices start falling out of the index and it just means that there will just be a natural push up on inflation.
Wall: So we’re not holding index-linked gilts, because as you said sometimes that can be quite expensive and indeed launched at the wrong time. What can we be holding in our portfolio to protect us from inflation?
Fane: So look there are, when you are buying any investment, what you are buying is you are buying a series of cash flows that extend into the future. And you can either buy cash flows that will specifically move with inflation. So inflation-linked bonds are one element that are actually tied to that inflation index.
But there are other things such as infrastructure, such as commercial property and even such as equities, where actually a retailer as prices are rising is likely to put up his own prices to the extent he or she can in order to sort of actually be able to maintain the wealth of the business that they are running. So a lot of these elements have the ability for their cash flows over the long term to move with inflation. The trick however is what do you have to pay for those cash flows.
Wall: So where do we find the yield that beats inflation at the price that’s right.
Fane: So we’re trying to run strategies that really are targeted at meeting inflation. Now absolutely if we can access that have that inflation proofing in the cash flows themselves, great, because that means we can buy them at the right price and we can just hold them and watch them grow. But actually what we do is we just evaluate all asset classes and say look even if you are getting a non-inflation protected cash flow.
If the pricing is cheap enough that actually the yields, you are being offered. So the income if you like on the price is significant enough real yield than actually we think we will be focusing only on those assets that we really think will allow us and will help us to meet that CPI plus target. It just means I think what you need to do is you need to be very selective. So some areas emerging market bonds, emerging market equities, energy assets to an extent some of these where the pricing really has been beaten down so much by what are in the end cyclical factors.
If we can pick companies that we think have the strength to survive that downturn and then actually potentially you are buying into cash flows into the future at a very attractive price that gives you that real return and should therefore protect you from inflation as we move forward.
Wall: Ed thank you very much.
Fane: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
