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How to inflation-proof your clients’ wealth

With inflationary pressure mounting across many industrialised and developing economies, investors are increasingly seeking ways to preserve the value of their assets. UK inflation, as measured by the consumer prices index (CPI), the Government's preferred measure, currently stands at 4.5%, but the Bank of England base rate has remained stubbornly low at 0.5% for over two years now.

So what can be done to protect your clients' wealth against the eroding effects of inflation? The traditional answer is to diversify their portfolios, but inflation is not really good news for the majority of asset classes. Over the longer term, equities usually outperform most other assets and keep pace with inflation, particularly when dividends are reinvested. In the shorter term, however, they can be far more risky, particularly when the inflation is associated with high commodity prices and rising energy costs.  Inflation

The two asset classes that are most likely to disappoint in an inflationary environment are conventional bonds and cash. Gilts have experienced around a 30-year bull market, but their peak has been forecast for some time - rising inflation and rising government debt means bigger risks for gilt holders, leading to higher yields and lower prices.

Although there is no perfect hedge against rising inflation, there is a fixed income sector that can offer inflation proofing. Index-linked bonds (both government and corporate) may hedge against inflation. Demand for inflation-linked bonds has increased as a result of rising commodity prices and indications that the Bank of England is prepared to hold firm on the base rate and tolerate higher inflation in the short term while economic growth is still weak.

Within both our global bond strategy and our multi-asset class strategies, our current fund allocations already incorporate some exposure to inflation linked bonds issued by the UK and other countries.

As we mentioned earlier, one of the key issues behind the higher inflation rate is the rising cost of energy, metals and food. Investing in actively managed commodity funds is one way to access this trend, although we should caution that the asset class is quite volatile. Gold is the classic inflation hedge and we are currently seeing prices hitting new highs, reaching a record price of $1,500 an ounce for the first time in April. We currently have both commodity and gold exposure within our multi-asset class portfolios.

We remain in uncharted waters given the events of the last two years and the massive public policy response implemented to manage the fallout. The prices of risk assets have risen sharply over a relatively short period of time and this momentum may stall, or reverse, on disappointing economic or corporate newsflow. However, asset class diversification, sound stewardship and a cautious approach remain our watchwords for 2011 as we build and manage the portfolios within our discretionary investment management service.

The global bond strategy and multi-asset class approach form part of our discretionary investment management service. To find out more about these services, please contact your relationship manager directly or our client services team on +44 (0)1624 645000.