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How to prepare for rising prices
A Q&A with Carl-Christian Höeg, Director of ETF Scandinavia at Lyxor ETF.
There is a lot of fear about inflation at the moment. What is behind this?
Inflation is back on the radar. After years of record lows, there is a lot of belief we could see inflation start to creep up again.
Inflation is a stealth tax on savers. It erodes the value of money in our wallet, in the bank. So when supermarkets threaten to pull products from their shelves over price arguments with suppliers, we know it’s a serious threat.
What’s driving prices higher?
In the UK, the biggest factor is weak sterling. According to Bloomberg, on 1st January 2016 a pound would buy you $1.47. By the 1st November it was $1.22 – 17% less. The knock-on effect is that imported goods become a lot more expensive.
But it’s not just in Britain. Take the USA – policies from the new administration could drive prices higher. Some expect an increase in spending in infrastructure projects, which drive prices rises more widely. And protectionist moves could drive up energy prices and wages.
So how should investors react?
Beating inflation is a goal for many portfolios – it is important investment managers take this seriously. We know many investors are reacting, buying inflation protected assets. There are a range of ways to protect a portfolio from inflation but they’ve each have different features. It’s important investors look at each option and understand how it works for their circumstances.
Give me some examples...
There are three main options. First is equity – companies can adjust their pricing to align with inflation. But some worry about short term reaction of equities. Many markets are close to record highs.
Next we have commodities – particularly gold. Again, this might provide a long run link, but again in the last few years the link has been weaker – as prices have mostly been falling.
The most direct way to get access to inflation is through index linked bonds – whose interest payments and capital values are directly linked to inflation.
Are investors buying linkers through ETFs?
*Yes, throughout 2016 ETF flows have grown by 32% (and done so in each quarter since January) while flows into active funds have declined by 1%. There does seem to be much greater awareness of the fact active managers aren’t always delivering what their investors need. On average, only 11% of active funds outperformed the FTSE MTS Eurozone Inflation-Linked bond index in 2015. Not one has outperformed the index over 10 years.
ETFs allow investors to buy a range of inflation linked bonds at are more flexible than standard ETF
What does Lyxor offer for inflation protection?
Lyxor offers a range of inflation protected investments. We’ve got 5 inflation-linked ETFs, covering the UK, Europe and USA. Currently, on 22nd November 2016, these are worth $1.5bn and costs start from just 0.07%.
What happens if there’s an interest rate hike?
Good question – central banks use interest rates to control inflation, so rate hikes could be down the line. Bond prices and interest rates tend to move in opposite directions – so even index linked prices could fall.
Earlier this year, Lyxor launched two new ETFs which could provide some shelter from central bank policy. The Lyxor US$ 10Y Inflation Expectations UCITS ETF (INFU LN) and Lyxor EUR 2-10Y Inflation Expectations UCITS ETF (INFL FP) were the first of their type in Europe. They should rise when expected inflation rises, but are duration hedged to give protection against rising interest rates. These have been very popular since we launched them in April – particularly the US Inflation expectations ETF.
Find out more information on Lyxor ETF and their range of inflation protected ETFs at www.LyxorETF.se
*Source for following figures: Lyxor, using Morningstar data from 31/12/05 to 31/08/2016. The figures relating to past performances refer to past periods and are not a reliable indicator for future results.
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