Taking the fight to inflation
Faith Glasgow finds out how UK equity managers are battling higher prices
The latest inflation statistics have not made especially happy reading. Although the headline rate is down to 8.7%, back in single digits for the first time since August last year, food price increases remain stubbornly near record highs at 19.1%.
The news depressed UK markets, leaving the FTSE 100 down 1.75% on the day, and has made further interest rate rises more likely too. "A further increase in Bank rate to 4.75% at the MPC's next meeting on 22 June, from 4.5%, now is firmly on the table,” reports Pantheon Macroeconomics.
Will Meadon, manager of JPMorgan Claverhouse investment trust, emphasises the fine line the Bank of England must walk in the coming months. “The key thing to do is to avoid stagflation – no growth combined with inflation,” he says. “The hope is that further rate rises won’t tip the economy into recession.”
Of course, the UK’s inflation problems are no longer new news: investment trust managers have been having to factor in the risks and potential impact of rising prices in their portfolio choices for more than a year now.
As Guy Anderson, portfolio manager of Mercantile investment trust, observes: “Rising inflation has caused challenges for many UK consumers and businesses, and remains a key headwind.”
“Rising inflation has caused challenges for many UK consumers and businesses, and remains a key headwind.”
It’s an environment where stock picking really comes into its own. The challenge is to find companies that are able somehow to pass on inflationary pressures without impacting earnings.
For Anderson, the focus is on companies where growth is being underpinned by “improving customer propositions” and increases in market share as a consequence of those initiatives, rather than being dependent solely on the uncertain strength of consumer demand.
He gives the example of homeware retailer Dunelm. Retail is a sector that tends to be particularly impacted by inflation as consumers find their budgets will buy them less; but Anderson is optimistic about the company’s prospects.
“Dunelm’s growth runway continues to be driven by an improving omni-channel customer proposition that is yielding continuing market share gains,” he says. "We believe that there is a huge amount of headroom for the company and future growth prospects are strong.”
Watches of Switzerland is another favourite. The company operates at the luxury end of the market, where it’s easier to pass on cost increases to wealthy buyers who have set their heart on a product.
It’s also increasing market share internationally, particularly in North America where Anderson says “sales of luxury watches are 40% lower per capita than the UK, providing an opportunity into this growth potential”.
“Wage increases will limit the scale of the decline in inflation.”
Job Curtis, portfolio manager of City of London investment trust, expects inflation to fall from the current elevated level as energy and food price increases drop out of the 12-month comparison, but warns that “wage increases will limit the scale of the decline in inflation” in months to come.
Meanwhile, though, he is focusing on the consumer staples companies making essential products that people find it difficult to do without, even as prices rise. He picks out Unilever, the food, personal care and home products multinational.
“The strength of brands is a key factor in determining how well a consumer staples company can absorb inflationary cost pressures. Those with weaker brands will suffer as consumers trade down to cheaper products,” he observes. “An additional benefit of this stock is that Unilever has a lot of experience in dealing with inflation in emerging markets.”
At Lowland Investment Company, manager James Henderson expects inflation to remain higher than it has averaged over the last 20 years not just in the months ahead but in coming years, given the pressure on companies across the board to find new and more sustainable ways of producing and delivering products.
“The move away from fossil fuels, and the sustainable agenda more generally, will put upward pressure on costs until a new infrastructure and work practices have been paid for,” he explains.
For instance, if it is to be more sustainably produced, food will have to cost more. That may be difficult for consumers, as again it’s difficult to reduce demand significantly; but higher food prices can benefit food retailers as they push up reported revenues.
“Tesco was a very good stock to own the last time inflation was relatively high in the 1980s, and it is performing well at the moment too."
“Tesco was a very good stock to own the last time inflation was relatively high in the 1980s, and it is performing well at the moment too,” Henderson says.
But Gervais Williams, manager of Diverse Income Trust, says the inflation picture could change significantly. Part of the whole issue goes back to the fallout from the Covid pandemic, which “both constrained supply and boosted consumer demand simultaneously, especially in areas such as home working technology and hardware.”
Through 2022 and 2023, he says, consumer demand has been suppressed by the Bank of England’s actions on rate hikes, while many pandemic-induced supply chain bottlenecks have now been resolved, which is likely to help bring prices of some goods and services down.
“Today, inflationary pressures are rapidly being displaced by deflationary pressures, and many companies may find they have to cut prices to keep their customers’ business."
“Today, inflationary pressures are rapidly being displaced by deflationary pressures, and many companies may find they have to cut prices to keep their customers’ business," Williams argues.
He therefore looks for companies that will be able to retain their current profit margins even when their competitors are cutting prices. “In this context, we like companies that are delivering not just good but outstanding service to their customers. It doesn’t guarantee they will hold onto their profit margins when others are cutting prices, but in our view it gives them a much better chance.”
One longstanding example in the Diverse Income portfolio is Hostelworld. “It provides strong service levels for booking hostels, as well as offering a range of useful services around these bookings. While it hasn’t paid out any dividends yet, we do expect it to generate surplus cash in due course,” he adds.
In the long run, equities provide a much better chance of beating inflation than cash deposits. However, in the shorter term it’s clear that an extended period of above-average inflation could prove as tricky for investors as it is for consumers.
