A plunge in headline inflation, as measured by the consumer prices index, earlier this week to 0.5 per cent for the year up to December makes the concern for runaway inflation seem implausible any time soon.
However, it did instead highlight worries that the UK could slip into a period where prices not only slow in growth, or disinflation, but actually start to materially fall – deflation.
In such a scenario economists fear that consumers and companies will hang back from buying goods and services because of the expectation that in the future these will only fall further. Therefore prices will continue to fall creating a vicious cycle.
The likes of Capital Economics have said they expect the UK to fall into deflation in the near future but this is already in a reality in the eurozone.
David Page, senior economist at AXA Investment Managers, agrees saying: “We expect it to fall further over the coming months. In the short term, inflation looks likely to dip to a negative year-on-year rate in February, with the low point likely in February or March depending on the continued fall in oil prices.”
However, both the team at Capital Economics and Page also agree that this may not be negative for investors as lower prices will mean higher consumer spending, which will generally be supportive for markets and cause any fall to be temporary.
Here we take a look at a few of the funds that two members of our AFI panel of leading financial advisers think may prove useful and/or fruitful if the UK does fall into deflation for longer.
Charles Hepworth, investment director at GAM, believes the rate of inflation will continue to fall until settling around zero. However, if it were to fall further and become deflationary then he would look for gilt exposure through the £50m Pimco GIS UK Sterling Inflation Linked fund, headed up by FE Alpha Manager Mike Amey.
“The only thing people rush to in those times are bonds but you can’t really argue they are outstanding value at the moment. However in a 2000s Japan-style deflation then bonds would be your answer. It would be a UK-centric problem so you want safety – certainly not overloading on corporates – and so straight vanilla gilts.”
“Amey has run the fund for many, many years and has done a pretty good job. We haven’t used it for ages now, because we sold out in 2012. It is not really indexed but more of an alpha play.”
The fund invests mainly in gilts of varying duration but also has some exposure to US government debt, although it is the fund’s smallest position at just 2.4 per cent.
“He plays around with duration and is looking for incremental alpha, which you can’t really find anywhere else in the gilt market, and it makes a good core holding for investors looking for sovereign gilt exposure,” Hepworth said.
Amey has managed the fund since its launch in 2003, over which time it has returned 136.7 per cent, 20 percentage points behind its index.
Performance of fund, sector and index since 2003
Source: FE Analytics
Paul Warner, discretionary fund manager and managing director of Minerva Fund Managers, also thinks deflation would be good for investors but suggests a UK equity income fund, alongside buying gold miners via two battered funds.
“The falling oil price means more people will have money in their pockets: do you think they will spend it or do you think they will expect prices to go down further so they will wait? I don’t expect the latter in this sort of economy,” he explained.
“Therefore the deflationary environment that people are talking about is good and means that real wages will rise. Come the second half of this year people will be surprised about how well the economy is doing.”
He likes the £577m Unicorn UK Income fund, co-managed by Fraser Mackersie and Simon Moon.
“They have definitely moved the fund toward the UK and consumer-oriented stocks and while you’re waiting for it to go up you’ll get a reasonable income.”
“I think small and medium sized companies are more likely to benefit in this type of environment.”
The pair have only managed the fund since January 2014 and so has just over a year of track record to look at on the fund. It has been a tricky year.
The fund is down 2.82 per cent compared to a fall in the FTSE All Share of 1.24 per cent and an average return in the IA UK Equity Income sector of 2.57 per cent.
Performance of fund, sector and index over 3yrs
Source: FE Analytics
Currently on a yield of 5.99 per cent, the fund’s largest holdings include BBA Aviation, Cineworld Group and Marstons. It has a clean OCF of 0.81 per cent.
Warner also says a gold fund may be useful during a deflationary period.
“Buying gold shares is not necessarily a bad thing because on the one hand you have a metal that holds value in an inflationary or deflationary environment but at the same time you have the cost of production of that metal falling substantially because of the oil price,” he said.
“However, whether it is the best bet at this juncture, I just don’t know.”
He likes the £932m BlackRock Gold & General fund managed by Evy Hambro or the £4m Charteris Gold & Precious Metals managed by Ian Williams.
“I have had BlackRock Gold & General fund for yonks in my ISA and it has done me quite well despite having a bad few years but if you really want to gear up you could buy the Charteris fund.”
Over the past five years the funds are both down significantly – 34 and 30 per cent respectively – but have stayed ahead of the FTSE Gold Mines index which has lost almost 55 per cent over the same period.
Performance of funds and index over 5yrs
Source: FE Analytics
However, the past few months have been more positive and both funds are up more than 10 per cent
The BlackRock Gold & General fund has a clean OCF of 0.81 per cent while Charteris Gold & Precious Metals has an OCF of 2.33 per cent.