According to the Office for National Statistics’ latest figures (14 Nov), UK inflation is holding steady, the headline CPI rate static at 3% for the month of October.
While no higher than the month before, inflation, often dubbed the ‘cruelest tax’, is however at a five-year high as the weak pound continues to put a strain on consumers’ purchasing power.
With real interest on cash accounts still effectively negative, the question of how to generate a ‘real return’ should be at the forefront of investors’ minds.
NEGATIVE REAL YIELD
Stock markets continue to climb higher and bond markets remain volatile, so investors are faced with further concerns that inflation could eat into the valuation of their cash.
Equities and bonds are arguably both expensive, while bank deposits are well below inflation, eroding savings in real terms. Even index-linked gilts – ‘linkers’ in the City lexicon – are offering negative real yields.
‘We’re in a world where everything is expensive and inflation could be the genie that pops out of the bottle,’ Ian Jensen Humphreys, Seven Investment Management’s (7IM) Senior Investment Manager, warned this week, ‘and once it pops out, it is hard to put it back in again.’
Among the collective funds with inflation-busting characteristics that investors could put on their watchlists is the 7IM Real Return Fund (GB00B75MS619), a £64.2m open-ended fund from the 7IM stable fronted by charismatic co-founder and financial guru Justin Urquhart Stewart.
The fund’s objective is to provide a total return that exceeds UK inflation (as measured by CPI) by 2% over a rolling three year horizon.
Stable, low volatility returns ahead of inflation are what the fund seeks through a diversified and eclectic portfolio.
Its strategies span yield assets, including other income funds (Fair Oaks Dynamic Credit (LU1344623373) and Carador Income Fund (CIFU) to give you a flavour) and an exposure to UK mortgages.
‘Losses on UK mortgages have been stunningly low through history,’ says Alex Scott, deputy chief investment officer, ‘well below 50 basis points in the worst ever year.’
7IM Real Return also runs a real assets strategy that includes holdings such as HICL Infrastructure (HICL), a generator of uncorrelated absolute returns, and LXI REIT (LXI) which has a portfolio of properties let to tenants on long-leases, almost all with inflation-linked rental uplifts.
Other portfolio portions are so-called directional assets including private equity-focused investment trusts such as Pantheon International (PIN).
Hedging and defensive positions include US treasuries and Source Physical Gold (SGLP), while 7IM Real Return also owns alternative risk premia assets; passive style or factor exposures which have minimal sensitivity to the bond or equity markets and can be found across a range of asset classes.
There’s a useful explanation of alternative risk premia by Goldman Sachs here.
UNDERSTANDING THE STRATEGY
As Matthew Yeates, 7IM’s quantitative investment manager, helpfully explains: ‘We own alternative risk premia assets for stable, low volatility sources of return.
‘Risk premia is another way of saying the return that is available for taking certain risk. It is a term that comes from the academic work on which many of these strategies are built.
‘The most common traditional risk premia are the equity risk premia and bond term premia.
‘The equity risk premia is the return available over the risk free interest rate for investing in the equity market.
‘The term premia in bonds is the extra return you earn for lending money over a longer time period (you can also think of this as the higher savings rate available for locking in your money for a longer period of time).
‘Both of these involve a risk above the risk free rate and so the premia is the increased return for taking that risk.
‘Alternative risk premia are sources of risk, that have different characteristics than the underlying broad market themselves. This includes styles of investing such as momentum, value, carry or even volatility.
‘As an example, the value risk premia is the return available for stocks that score well on a value metric, versus those that score poorly on a value metric.
‘A frequent way of implementing this could be to buy £1 of stocks with good value and sell £1 of stocks with poor value. This reduces the net exposure to stocks as a whole (and therefore the market) to £0 but leaves an exposure to the difference between good and poor value stocks.
‘If you believe in the returns available from that style it should lead to a positive return over time that isn’t simply coming from the market.’
The idea of many investments in this bucket are to isolate the return from this style whilst removing the exposure to the underlying market. This can give a stable source of return over the long term that is independent of the underlying market beta.’