Last Tuesday it was announced that the UK consumer price index (CPI) rose to 0.5 per cent in March, which means inflation is at its highest level since December 2014.
This led to a mixed reaction from investors – while bulls are optimistic that if this trend continues it will boost economic health and therefore market sentiment, those who hold bonds are less excited given the fact that the value of their portfolios could decrease.
Given the variety of impacts that inflation could have on investors’ portfolios, FE Trustnet asks a panel of investment professionals which funds could either hedge against any negative side-effects or thrive under healthier inflation conditions.
M&G UK Inflation Linked Corporate Bond
Adrian Lowcock, head of investing at AXA Wealth, says that while rising prices are generally good news for the economy, consumer confidence remains subdued and warns that this could spread into other market areas where prices could rise, such as oil & gas, supermarkets and pharmaceuticals. 
As such, he would opt for M&G UK Inflation Linked Corporate Bond, which is managed by Ben Lord (pictured) and deputy managed by Jim Leaviss.
As the name suggests, the fund aims to protect against the effects of inflation by outperforming the CPI index over a rolling three to five-year period.
“Manager Ben Lord uses derivatives to create synthetic index linked corporate bonds because the investment universe is too small to build a liquid portfolio,” Lowcock said.
“The fund has had a poor year as inflation outlook deteriorated at the start of the year and the trend towards negative rates and falls interest rates gathered momentum. However, it rebounded strongly in March.”
The fund has an FE Risk Score of 25, which suggests it has shown one-quarter the volatility of the FTSE 100 index over recent years, and it is in the top decile for its annualised volatility and its downside risk (the asset’s potential to decline during negative market conditions) over five years.
Given the weak inflation environment it has underperformed the IA Sterling Strategic Bond sector average by 18.54 percentage points over five years with its total return of 7.27 per cent. However, it has also underperformed CPI, which has returned 8.68 per cent over the same time frame.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics (data from latest available date)
M&G UK Inflation Linked Corporate Bond has a clean ongoing charges figure (OCF) of 0.66 per cent.
Legg Mason ClearBridge US Aggressive Growth
FE Alpha Manager David Coombs, who heads up a number of portfolios at Rathbones, says inflation expectations have been largely overestimated and argues growth funds will therefore remain in favour over the medium term while value funds struggle to provide returns.
In terms of regions, he believes that the US currently offers the strongest growth prospects and therefore believes that Legg Mason ClearBridge US Aggressive Growth will provide attractive returns in today’s inflation environment. The US has also seen inflation nudge up recently.
“If growth surprises to the upside and interest rates rise this would be a good fund to be in. I would still be very careful about index-linked funds even if interest rates surprise to the upside - remember there’s a lot of duration risk in index-linked, it isn’t straightforward so you have to be very careful here,” he said.
“It’s growth that beats inflation, not value. We like the Legg Mason fund because we’ve known the team for a long time, they are very disciplined and high conviction in certain areas of the market and they don’t play around in areas that they don’t understand.”
“They do tend to have a bias towards healthcare, which has had a tough time recently, and they do like biotech, which is an area that I think is really exciting. They have a really disciplined, long-term approach.”
The $3.1bn fund, which has five FE Crowns, has been headed up by Evan Bauman and Richie Freeman since 2007 and over this time frame has provided a total return of 123.56 per cent, outperforming its average peer by 17.23 percentage points.
Performance of fund vs sector and benchmark under Bauman and Freeman
Source: FE Analytics
Legg Mason ClearBridge US Aggressive Growth has a clean OCF of 1.11 per cent.
M&G Global Floating Rate High Yield
Steve Lennon, investment manager at Parmenion, says equities, precious metals and energy traditionally do well during periods of increasing inflation. For those holding fixed income, he would expect index-linked gilts, floating rate notes or high yield to outperform sovereigns or government bonds.
He would therefore choose M&G Global Floating Rate High Yield, which is managed by FE Alpha Manager James Tomlins, to fare particularly well in a rising inflationary environment.
“With a very low duration of 0.1 years at the end of February and a distribution yield of 3.79 per cent, this fund has attracted significant flows since its launch in September 2014,” he said.
“The floating rate note exposure means that the yield should keep pace with changes in interest rate expectations. Indeed, the fund has demonstrated a very strong correlation with RPI [retail price index] of 0.95 since launch, according to FE.”
Floating rate notes (FRNs) pay a variable coupon that adjusts in line with interest rates and M&G Global Floating Rate High Yield focuses on those that are issued by companies with a low credit rating and therefore pay higher levels of interest.
This means that, while the fund has a top-decile annualised volatility since launch and an FE Risk score of 24, it still currently yields 3.56 per cent.
What’s more, it has outperformed its peer average in the IA Sterling High Yield sector by 101 basis points since launch with a total return of 72 basis points.
Performance of fund vs sector since launch
Source: FE Analytics
M&G Global Floating Rate High Yield has a clean OCF of 0.83 per cent.
