The most important issue for all investors today

‘Learn from yesterday, live for today, hope for tomorrow. The important thing is not to stop questioning’ - Albert Einstein

You should always be focused on inflation as an investor…and this counts for double today. You probably saw earlier this week that the UK’s headline rate of inflation rose to its highest level since late 2014 in September. Admittedly the consumer price index hit just a 1% level but the uplift trend is clear. Factor in the impact of the weak Pound and the falling out of the early 2016 ultra-low oil prices over the next few months from the year-on-year numbers and we will see a 3%+ inflation print in the UK before the end of 2017.

Whilst this is small beer for those schooled in the volatility of the 1970s and 1980s it reflects a sharp break with the prevailing low/no inflation theme that has helped drive bond yields to ever more negligible levels in the last few years. And as yields go down bond prices go up generating huge gains for bond investors since the time of the Global Financial Crisis just under a decade ago.

Rising inflation however significantly reduces the attractions of bond investment today. That just over 1% yield that you get today for your 10 year UK gilt (government bond) will get nowhere near to covering inflation over the next year and quite conceivably the next few years. If you want to reduce the purchasing power of your investments fast then government bonds are a good place to start…and most corporate bonds will struggle to help you out too.

So what should you do? Well the professionals – institutional fund managers – have made their call: they prefer cash. The biggest regular survey of fund managers observed earlier in the week that bond allocations relative to cash allocations is now at its lowest level since July 2006, meaning that professional investors are showing a clear preference for cash over those unattractive bond assets.

Unbelievable! At least bonds are giving some yield and I am not apocalyptic enough in my views to countenance any large developed countries – or even FTSE-100 companies – would default on their bonds in the next decade or so. Cash is giving you even less yield and I am afraid this is unlikely to change much for the foreseeable future in the UK or in the broader European area. Nevertheless these large global investors when surveyed have cash levels close to a 15 year high.

I would not copy what the professionals are on average doing. The only real way to protect yourself is a mix of equity and real assets. The former is of course the classic asset class to switch to when you sell bonds or want to move out of cash. However this generally happens when the world economy is moving out of recession and into a period of clearly stronger growth and that is not the case today.

This is why you have to dust down those stock selection skills and not buy cheap index funds. The key differentiator for an equity to outperform is going to be pricing power, in short an ability for a company to raise its prices at least in line with any underlying inflation rate. From this capability earnings and cash flow – which are the real determinants of share prices – will occur.

So equities can work…and so can real assets like gold or classic cars or watches or art. My rule of thumb is that your investment portfolio – which does not include the house you live in – should have about 10% in real assets. Gold should be your default position given its historic longevity and relative ease of access but if you have a real knowledge base in one of the other areas then my suggestion is to go for it…otherwise you may find via your pension fund manager that you are holding a whole load of cash.

So welcome back to a bit of inflation…and a reiteration that protecting yourself from a rising price level is the critical first aim of your investment policy.

Chris Bailey has 20 years of investment industry experience at long-only and long-short institutions as a global multi-asset fund manager, strategist/macro thinker and, in the earlier part of his career, as a securities and fund analyst.

In 2013 he founded Financial Orbit focusing on daily macroeconomic comment and securities analysis.

The content on this page does not constitute financial advice and is provided for general information purposes only. Nothing on this page should be regarded as an offer to conduct investment business or to buy/sell any investment