Investing to beat inflation
In this article, Tom Hibbert, Multi-Asset Strategist, explores the relationship between investing and inflation: why it resurfaces, how it impacts portfolios and the strategies Canaccord Wealth uses to help protect against it.
Quick summary: investing to beat inflation
How to invest to beat inflation is a question we’re often asked. Inflation quietly erodes the real value of wealth, making it one of the most persistent threats to long-term investment returns. While equities have historically outpaced it, periods of high inflation can be especially damaging to markets and portfolios.
1. How does inflation relate to investing?
Inflation reduces the value of your wealth and while equities can provide returns over time, they don’t always hold up by themselves when inflation surges. At Canaccord Wealth, it’s our job to stay ahead of these risks through smart diversification and active protection.
2. Government debt, inflation and your money
Government debt and inflation are closely linked: when spending runs ahead of revenue, inflation can become a tool used by governments to quietly reduce that debt. As your wealth manager, we actively account for this risk by reducing exposure to vulnerable assets and building portfolios designed to help protect your money in a high-debt, high-inflation world.
3. How to invest to beat inflation
Beating inflation requires more than just riding out the storm - it means actively building in protection. We do this through a diversified mix of assets that can respond to rising prices, from inflation-linked bonds and gold to quality equities and alternative strategies. It’s a forward-looking approach designed to help preserve the real value of your wealth.
The universal tax
“Inflation is taxation without legislation. It is the most universal tax of all – as violent as a mugger, as frightening as an armed robber, and as deadly as a hitman. It is the last resort of bankrupt governments.”
Combined insights from Milton Friedman, Thomas Sowell, Ronald Reagan and Ludwig von Mises capture inflation’s brutal reality. As custodians of our clients’ wealth, inflation is our nemesis. It is our job to invest to beat inflation and protect the real value of client portfolios.
Over time, this should be relatively simple. The equity risk premium, or the reward for taking on the higher risk of investing in stocks, has historically exceeded inflation. So, by owning a diversified portfolio of global and UK equities, investors should achieve a positive real return across an economic cycle. This is central to how we invest over the long term.
If only it were so easy in practice. Inflation is not a linear phenomenon. Sometimes it is benign. At other times, it surges - it is in these moments that it becomes truly dangerous.
Recent research shows that during inflationary regimes, US equities have delivered an average annualised real return of -7%, while UK equities, more tilted towards the value-oriented energy and materials sectors, have fared better with an average annualised real return of 0%1.
In 2022, global equities delivered a real return of -19.0% for a UK investor. The evidence is clear: equities cannot be relied upon exclusively to protect against inflation during inflationary regimes. Instead, a diverse investment strategy is crucial.
The graph below shows that a multi-asset portfolio like the Canaccord Wealth Risk Profile 4 portfolio - with around 47.5% in global bonds, 40% in global equities and 2.5% in cash - has grown from £100 to nearly £300 since 2004. Over the same period, the ARC Sterling Balanced PCI (a benchmark for medium-risk UK portfolios) rose to around £263. Meanwhile, the inflation line highlights that you’d now need £181.20 to match the spending power of £100 in 2004.
Sources: Canaccord Wealth, Bloomberg
Bankrupt governments and financial repression
“Inflation is always and everywhere a monetary phenomenon… in the modern era the important reason for excessive increases in the quantity of money has been because governments wanted to spend money and were unable to raise taxes sufficiently to pay for it.” - Milton Friedman
Governments have printed and spent too much money in recent years, particularly with the ultra-stimulative policies adopted during (and after) the COVID-19 pandemic.
For some countries, outgrowing that debt is an unrealistic mathematical hurdle. Financial repression through inflation becomes the escape hatch. As Thomas Sowell said, “inflation is the last resort of bankrupt governments”.
Although inflationary pressures are currently subsiding, upside risks remain. Over the medium to long term, another inflationary cycle is not just plausible but likely, particularly without fiscal consolidation – a drastic reversal in government spending habits.
For us, this means embedding protection into portfolios through asset allocation and security selection. When inflation risks are present, we reduce exposure to assets vulnerable to inflation (such as government bonds and certain equities) and prioritise protective assets.
How to invest to beat inflation
We use a diverse investment strategy for inflation that includes:
Asset-backed securities (ABS): ABS generally have floating interest rates, which can be beneficial during inflationary periods as payments adjust upwards alongside central bank rates. In addition, ABS are collateralised; their value is derived from pools of underlying assets, which themselves may appreciate in nominal terms during inflation.
Inflation-linked bonds: These bonds are tied to specific inflation indices, increasing in principal and income as inflation rises. We favour US TIPS (inflation protected government bonds), which currently offer attractive real yields. However, valuation is critical; if purchased when real yields are low or negative, their inflation protection can be undermined. Active management in inflation markets has added significant value and embedded inflation protection into our portfolios at attractive valuations.
Commodities: Commodities like oil and agricultural products often benefit during inflationary periods. This is because demand for commodities tends to be strong during inflationary periods. Research suggests that commodities are the only statistically significant asset class to deliver real returns during bouts of inflation.
Commodity-related equities: Companies involved in the production, processing, or trading of commodities tend to see earnings rise when commodity prices increase. For example, gold miners benefit from higher gold prices. We prefer gold miners currently, as they are undervalued relative to spot gold (current market price).
Gold and precious metals: Gold remains the ultimate safe-haven and arguably the ‘truest’ form of money. Unlike financial assets tethered to central bank policies, gold stands outside the system; it cannot be printed or defaulted upon (in the case of physical gold). In an environment of rising debt burdens, inflation and stealth erosion of wealth, gold could prove the best place to hide.
Liquid alternative strategies: These involve investments uncorrelated with traditional markets, providing potential hedges against inflation. We favour trend-following strategies, which capitalise on persistent market moves by going long in upward trends and short in downward trends. Inflationary regimes often create powerful, sustained market trends.
Short-dated credit: With lower duration risk, these bonds are less sensitive to rising interest rates, while their higher yields provide a meaningful income cushion against eroding real returns. In an environment of persistent inflation and elevated policy rates, short-dated corporate bonds can enhance portfolio resilience, capturing attractive yields without the vulnerability of longer-term fixed income.
Quality equities: Companies with strong pricing power, high margins and sustained profitability can offer a degree of inflation protection. Businesses able to pass rising input costs onto customers without eroding demand can maintain or even grow their real earnings during inflationary periods. We favour quality equities with robust balance sheets and durable competitive advantages as part of a long-term inflation defence.
Fighting back
“By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.” John Maynard Keynes
Inflation is the most insidious tax, eroding wealth silently and relentlessly.
In the long run equities outperform inflation but they are vulnerable when it bites. Effective inflation protection requires diversified strategies: assets with pricing power, investment instruments directly linked to inflation and alternative strategies uncorrelated with traditional markets.
By embedding these defences in portfolios and actively asset allocating, we aim to fulfil our core duty: preserving and growing clients’ real wealth across market cycles.
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