Look beyond traditional asset allocation for sustainable inflation-linked returns

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Atrato Group’s Steve Windsor explains why sticking to assets that have outperformed in the past could leave investors struggling to keep pace with inflation.

Although the consumer price index in the UK has reached its highest level in four decades, we believe that the peak of inflation is yet to come. We expect a period of above-trend inflation that will last until at least mid-to-late 2023 – much longer than many market participants anticipate. This means that investors will have to seriously rethink the positioning of their portfolio.

Clearly, the high inflationary environment will favor a very different set of assets than those that have generated strong returns during the period of low rates and low inflation seen over the past decade. Although high-growth, low-profit (if any!) tech stocks made impressive returns before inflation set in, they are much riskier assets to hold in a higher cost of capital environment. raised.

We think investors could reposition portfolios to focus on real assets, where value is intrinsically tied to inflation. Real estate, infrastructure and commodities are well known for their ability to generate resilient returns in an inflationary environment. Within these, however, some assets are better positioned than others.

In particular, investors should look for assets that can provide reliable inflation-linked cash flows over the long term – the ultimate refuge in an inflationary environment. Real estate assets that are leased under inflation-linked leases to quality tenants such as large institutional firms can provide such security. Additionally, some sectors that serve basic consumer needs tend to be less cyclical and therefore likely to outperform during periods of macroeconomic uncertainty.

Grocery sector

Although food prices are a key driver in the current high inflation environment, the grocery sector remains quite insulated from economic conditions due to the indispensability of such household spending. The grocery sector in the UK is dominated by large institutional companies. So far, supermarkets have been able to pass on most of their inflationary pressure to consumers and have managed to protect their margins.

Green energy

The other real asset sector we like in the current environment is green power. The green energy sector sits at the confluence of two very powerful investment themes: structural inflation in global energy prices and the net zero environmental agenda. Energy prices soared and became much more volatile. Therefore, more and more companies are looking for alternative energy production solutions to source electricity at a lower cost than buying from the grid. Indexed power purchase agreements (PPAs) with the company to buy green electricity generated by solar panels are becoming increasingly popular as a solution. PPAs typically have an average term of 15 years with the occupants of the commercial properties on which the solar panels are installed, allowing stable long-term returns linked to inflation.

Social housing

There are also opportunities for inflation-indexed income in areas such as social housing, which is government funded and for which there is insufficient supply. This sector also provides a clear social benefit by supporting the provision of appropriate housing for vulnerable people. Finding government-backed inflation-linked cash flow that can be achieved during a rally in pegged gilts has become something of a holy grail for inflation-savvy investors.

If inflation tides remain high for the foreseeable future, investors clinging to assets that have outperformed in the past could find themselves ill-equipped to navigate the potentially choppy waters ahead. To ride out this inflationary storm, investors need to recognize that the next period of the investment cycle is likely to favor fundamental investments and real assets.

Steve Windsor is director and co-founder of Atrato Group. The opinions expressed above should not be considered investment advice.

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