As UK inflation soars to a 30 year high, IFA Magazine’s Peter Wilson talks to Aviva’s Jean-Paul Grenade about how and why today’s inflationary environment poses such challenges for advisers’ clients and why smoothed investment funds might offer an effective solution
PW: Why is rising inflation a problem for investors and savers?
JG: Rising inflation has not been an issue for a significant period of time. However, we now face not only the prospect of the highest inflation rates seen for decades but also the position where many people have elevated cash holdings as a consequence of the Covid restrictions. Because of the pandemic, people haven’t been able to spend their money on a new car, a holiday, or any of the nice things that people typically want to put their money towards. In some instances, that’s been a positive thing – for example, in terms of those who have reduced debt, which is good for the individual as well as the economy. However, as advisers will know, the main issue is that inflation at a high level erodes the purchasing power of that cash.
I recently wrote an article which you may have seen in FT Adviser, where I relayed a story which brought the real impact of inflation to life for me. Back in 1989, when we first started looking at CPI inflation, you could buy a Lada Riva for around £3,500, which was the cheapest car available in the market at the time. If you fast forward to 2022, the cheapest car in the market is a Dacia Sandero, which is about £10,000. If you had your money in cash, the £3,500 would broadly still be worth £3,500 which, today, is probably enough to buy the likes of a MacBook Pro, for example. In effect, you have turned your car into a very nice laptop – but that laptop isn’t going to help you get to the train station. However, if you kept up with inflation, you might need a bit of a discount, but you probably would still be able to buy the cheapest car available in the market today – and that’s why it’s important. It’s about maintaining purchasing power over time.
The other thing to consider is bonds. If inflation continues to rise and remains stubbornly high, the Bank of England will raise interest rates further to combat that inflationary pressure. Of course, if bond yields rise the price goes down. Those two areas are the key problems we face with rising inflation, which we haven’t had to worry about in the past but do need to worry about now. In addition, I think as we move forward, we will see inflation have an impact for longer than we previously anticipated.
PW: How long do you think this higher inflation we’re seeing at present is going to last in the UK?
JG: I do not believe this inflationary spike is transitory but that it is likely to be sustained for certainly, the next couple of years and a primary reason behind that is wage inflation. In the past, when we looked at what happened with inflation, it had been contained by the fact that although prices were rising, there was no inflationary pressure on wages. That’s changed this year. In fact, towards the end of last year, we saw supermarkets going on strike and rejecting 4% pay rises as too low. There are also plenty of jobs available in the market and that, combined with natural inflationary pressure, people feeling that energy squeeze – and therefore putting pressure on employers to increase their pay so they can afford their household bills etc. – means inflation is likely to be sustained for some time yet.
PW: Which asset classes do you believe could perform better if high inflation is likely to continue?
JG: I think it’s easier to start by saying which asset classes are not going to perform as well in a high inflation environment.
Even though interest rates on cash would rise, it’s likely that its real value will still be eroded. For example, if UK Base Rate goes up to 2%, and inflation is currently at 5%, cash savers are likely to lose out -especially when tax is taken into account.
Bonds are interesting because of the inverse relationship between yields and capital values. If a bond yield goes up, the cash value of that bond will go down. We would therefore expect to see bond prices come down as interest rates rise because investors will start to demand more (higher yields) – for taking on the risk that comes with bonds when interest rates for cash are already higher. I think bonds could be particularly interesting as we’ve had a prolonged period of low and falling interest rates for many years. This has been great for bonds and has meant that, until now, bond prices have just gone up and up. So bonds are definitely an asset class to watch.
Typically, though, you’d expect assets such as commodities and equities to do well in an inflationary environment. Therefore, the strategies that multi-asset fund managers are going to have to use going forward are likely to incorporate an increasing exposure to equities and a decreasing exposure to bonds.
In addition, where multi-asset fund managers have exposure to bonds, they will look to reduce the duration of their bond portfolio– that is, the length of time it takes to get your money back. Within our product, we would probably be down at 1.5 duration, which is very low. I expect that most asset managers are keen to move in that direction to ensure that their bond portfolios are less sensitive to interest rate changes.
PW: How can Aviva provide advisers’ clients with greater certainty for their investments?
JG: There are a number of different ways that advisers can give their clients exposure to the market. One of the ways in which Aviva has been helping clients to gain market exposure, whilst also giving them a greater certainty of outcome, is through Aviva’s Smoothed Managed Funds.
We have two versions: one is slightly lower risk – at low risk – and the other is slightly higher risk – at low-to-medium risk. At outset, these funds provide clients with an expectation based on the Bank of England base rate plus a certain amount, depending on what fund or product the investment is in.
A positive aspect of this is, in today’s inflationary environment where you’d expect the Bank of England to raise rates, that clients’ smoothed growth rate should rise in line with that Bank of England base rate. So, it’s a really effective hedge against this specific problem that we are seeing now, in our current high inflation environment.
I think that’s one of the better ways in which an adviser can help their client to:
1. Dip their toe in the water in the investment markets
2. Have a reasonable degree of confidence in terms of what their overall long-term outcome should be, and
3. Protect themselves and the value of their investment against the impact of further Bank of England base rate rises.
If we consider a scenario where we might see eight more rises to bank rate in the next two years and if we assume these are in the margin of a 25 basis point increase each time, we would see a 2% rise in overall rates. In effect then, our Smoothed growth rate should increase by 2% by the end of that period, just through Bank of England base rate rises.
Therefore, I believe that our Smoothed Managed Funds can provide advisers’ more risk averse clients with a great opportunity to get involved in the markets in a way that is in keeping with their risk tolerance as well as helping them to achieve their investment goals for the long term.
Want more information? Get the facts about the funds in our Smooth Managed Funds Hub.
Would you like to speak to a Smooth Managed Fund expert? Email my team at investmentspecialistsalesteam@aviva.com to arrange a call back.
About Jean-Paul Grenade, Head of Investment Specialist Sales
Jean-Paul (J-P to everyone) is Head of Investment Specialist Sales at Aviva. He joined Morley Fund Management as a Business Development Manager in 2007. Morley became part of Aviva Investors when it was launched the following year, meaning J-P has been an integral part of the business from the start. He’s been in financial services for 22 years, has an ongoing fascination with the economy and enjoys a good discussion about the investment markets.
