Over the past few weeks, two remarks by investment professionals I greatly respect have been rattling around my head. One commented that no one should be investing until they have built up a “sure thing,” by which he meant a decent sum in index-linked government bonds. The other, a veteran adviser to the UK’s largest pension funds, lamented the problems they now face and confessed: “I’d be happy just to get RPI [Retail Price Index, a measure of inflation].”
Their words come to mind now because what has been implicit for a while is becoming overt—inflation is back. Since Mark Carney was confirmed as the next governor of the Bank of England, serious people have even debated ditching the Bank’s 2 per cent inflation target (which it hasn’t hit in a long while anyway). Partly as a result of this, market-based signals of inflation expectations reached a four-year high in mid-March, propelled upwards also by the effect of the sterling’s recent weakness on the price of imported goods.
So higher inflation looks inevitable, not least because without it we have precious little hope of ever clearing our vast debts—inflation erodes the value of our liabilities in exactly the same way as it eats away at the value of our savings.
The chancellor’s budget revealed that the inflation target will remain—if only to be more honoured in the breach than the observance. But it also revealed that preserving our capital against inflation is not going to get any easier, because the classic route, index-linked savings certificates from the state-owned investment organisation, National Savings & Investments (NS&I), will not be on sale for the coming tax year (yet again). For those lucky enough to have bought these when they were available, the option remains to reinvest the proceeds when they mature (the current rate is RPI inflation plus 0.15 per cent).
Inflation poses two distinct problems for investors: capital preservation and income growth. The NS&I certificates do a great job of preserving the value of your capital by linking it to inflation, but they pay no income. The surest way to preserve the value of your capital and to create an inflation-linked income is to own index-linked government bonds (UK or US, depending on your appetite for currency risk).
Or at least it was. Even these don’t work perfectly nowadays because demand for them is so high that they are now being…