The six alternative funds for rising interest rates and inflation

Financials, miners and infrastructure stocks could serve as havens from rising inflation and interest rates, providing some comfort to investors.

Interest rates and inflation are not factors investors have had to deal for many years, with central banks maintaining very loose and accommodative monetary policy brought in to deal with the 2008 global financial crisis.

The Covid pandemic swiftly forced the economic and policy backdrop to change though and during the past year of recovery central banks were strongarmed into raising interest rates up off the floor in an effort to deal with the rising costs and inflation caused by months of lockdowns.

Earlier this month the Bank of England doubled interest rates to 0.5% after making its first increase in late 2021 to 0.25%, the first time in 18 years that it has increased rates at two consecutive meetings.

In the US the Fed’s chairman, Jerome Powell, has stepped away from his previous ‘inflation as transitory’ stance and taken on a more hawkish tone, which equity markets have steam rolled ahead with, pricing in at least three rate hikes from the Fed this year despite no confirmation.

The fact that markets are pricing in higher levels of interest has forced investors to revaluate their portfolios since many of the assets that flourished previously now face significant headwinds. Growth stocks have been the biggest story, having led markets for several years but suffering in the near term.

As many investors face a portfolio in the red, Trustnet asks experts which types of assets should do well in the new environment and what funds they should hold to access them.

Financials

The first area was financials, specifically banks, which have not received a lot of love from investors since 2008. But banks have traditionally been able to capitalise on rising interest rates because the borrowing rates increases faster than savings rates. With markets swimming in more debt than ever, this plays into bank’s favour.

Ryan Hughes, head of fund selection at AJ Bell, said: “Given the vast sums banks hold, the borrowing rate only needs to move a few basis points for a material increase in profitability and with interest rates likely to see a number of increases through 2022, this could put the turbo boosters under bank profits for the months ahead,” he said.

As a play on this, Hughes picked the Xtrackers MSCI World Financials ETF, which has around 40% exposure to banks. With an ongoing charges figure of 0.25% the ETF is a cheaper option for investors wanting to branch out their portfolios.

Performance of ETF since launch

Source: FE Analytics

But for those who want a more active approach, Kate Marshall, lead investment analyst at Hargreaves Lansdown, chose the JOHCM UK Equity Income fund.

The fund has a history of heavily investing in financials, which makes up more than 30% of the portfolio – its biggest sector weighting and a massive overweight relative to other IA UK Equity Income funds, which average a 9% position.

Marshall added that the experienced managers, James Lowen and Clive Beagles, take a contrarian view and invest in undervalued companies which could provide an attractive income.

This UK fund pick has more domestic exposure than the global ETF, but financials make up a big part of the UK equity space, especially at the large-cap end where this fund is mainly concentrated.

The £2.2bn fund has a yield of 3.82% and made a total return of 345.7% since launch, beating its sector and benchmark.

Performance of fund vs sector and benchmark since launch

Source: FE Analytics

Mining and natural resources

During periods of higher inflation pricing power becomes essential as it enables companies to pass on the added production costs to the consumer, thereby preserving profits. Companies without this ability would likely struggle to stay ahead.

According to Hughes, miners have this advantage “because they have a scarce resource which is in demand”, particularly now as companies are trying to fulfil post-Covid demands for products.

As a result, Hughes expects to see underlying commodity prices increasing, something that is already happening to oil for example, which has risen above the $90 per barrel mark recently.

If commodity prices increase, this should boost the profitability and dividend potential among mining stocks, Hughes said.

For this theme both Hughes and Marshall highlighted BlackRock funds: the former, BlackRock World Mining and the latter, BlackRock Gold & General.

Both funds are run by Evy Hambro but invest differently. Hughes said the BlackRock World Mining fund was a “standout choice”. It invests in the miners of various precious metals and materials but does not hold any physical gold or silver.

For investors who prefer the ‘classic safe haven’, Marshall’s choice is the UK’s longest established unit trust specialising in gold. It gets its exposure from well-managed, larger gold miners that have strong balance sheets, as well as having exposure to other precious metals and minerals.

The BlackRock World Mining has been the better performer out of the two over 10 years, making 14.1% versus a loss of 18.8%, but this was still an underperformance versus the wider sector.

Performance of funds over 10yrs

Source: FE Analytics

Infrastructure

Another way investors could profit from inflation is via infrastructure, another “scarce resource that is hard to replicate”, Hughes said.

Peter Meany’s First Sentier Global Listed Infrastructure fund could be a “core product” for investors trying to navigate inflation, offering a “well diversified global portfolio”, he said.

The fund invests across the infrastructure landscape, investing in power, road, rail, utilities and oil and gas storage, all backed by a “well resourced and experienced team”, according to Hughes.

Since it launched the fund made a total return of 234.5%, beating the average IA Infrastructure fund (149.2%) but lagging its benchmark (261.5%).

However, Marshall said it is not just finding funds that can capitalise in inflationary environments, but ones that can deliver when the market changes.

For this, Marshall, selected the HICL Infrastructure trust, which provides long-term, sustainable income from a host of social infrastructure assets, such as hospitals, public sector projects, utilities and transport infrastructure, all areas she said will be in demand regardless of inflation, making it a good defensive option.

Performance of fund vs sector and benchmark since launch

Source: FE Analytics

Since its inception the trust has stormed ahead of its average sector peer, making 280.8% versus 123.5%.