ETFs to consider as inflation erodes cash’s real value

May 2nd, 2017 | By | Category: Alternatives / Multi-Asset

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Seventy percent of financial advisers predict that an increasing number of clients will switch some of their capital out of cash and into other asset classes in response to rising inflation. That’s according to a study of 108 UK-based financial advisers commissioned by Investec Wealth & Investment.

ETFs to consider as inflation erodes cash’s real value

Seven in ten (70%) financial advisers predict an increasing number of clients will switch some of their capital out of cash and into other asset classes in response to rising inflation.

CPI inflation has risen sharply over the last year from 0.3% to 2.3% in the year ended February 2017. In contrast, since June 2016 and the Brexit vote, average cash ISA rates have halved from 0.87% to 0.43%.

With inflation eroding the future real value of investors’ cash savings, almost two thirds (64%) of advisers surveyed believe clients will begin to alter their perceptions of cash as a ‘safe haven’ asset.

Mark Stevens, head of intermediary services at Investec, said: “Whilst interest rates had remained at historic lows for eight consecutive years alongside negligible rates of inflation, cash has retained its reputation as a safe if rather unexciting asset class. However, with inflation rising significantly in recent months, many advisers believe their clients’ patience with cash will start to wear thin as they see their deposits shrinking in real terms.”

The findings suggest investors may begin shifting some cash assets further up the risk spectrum in an attempt to avoid negative real returns. Potential asset classes for consideration include inflation-linked government bonds, short-duration corporate bonds and hard assets such as commodities, exposure to which can be gained via exchange-traded funds (ETFs).

Inflation-linked bond ETFs provide investors with an inflation hedge as the principal of these issues increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When the bond matures, investors are paid the adjusted principal or original principal, whichever is greater. The bonds pay interest twice a year, at a fixed rate. The rate is applied to the adjusted principal; so, like the principal, interest payments rise with inflation and fall with deflation.

Potential plays in this space include the £1.0 billion AUM iShares £ Index-Linked Gilts UCITS ETF (LON: INXG) or the Lyxor FTSE Actuaries UK Gilts Inflation-Linked UCITS ETF (LON: GILI) which, with a total expense ratio of 0.07% is cheaper than the 0.25% charged by iShares, but has much less assets at £187m.

Investors may also wish to consider short-duration investment grade corporate bonds which offer a premium for taking on the credit risk associated with corporate debt. By investing in shorter maturity bonds, however, the investor remains relatively unexposed to duration risk – an increasingly important consideration as central banks look to normalise rates in the future.

The iShares £ Corp Bond 0-5yr UCITS ETF (LON: IS15) tracks sterling-denominated investment grade corporate bonds with a remaining maturity of less than five years. The effective duration of the portfolio is 2.4 years and the largest credit quality exposure is to bonds on the cusp of speculative grade, rated ‘BBB’ (53.4%). This allows the investor to earn a reasonable credit risk premium without straying into the junk bond territory. The fund has £1.3bn in AUM and a TER of 0.20%.

Another option is the SPDR Barclays 0-5 Year Sterling Corporate Bond UCITS ETF (LON: SUKC) which has similar characteristics – an effective duration of 2.3 years and significant exposure to bonds rated ‘BBB’ (54.3%). It has £84m in AUM and a TER of 0.20%.

Commodities, especially hard commodities (those which can be stored), have historically provided a good hedge against inflation. Commodities in general may also be used to diversify portfolios.

ETF Securities offers the ETFS Ex-Agriculture and Livestock ETC (LON: XFRM) which has $102m in AUM and a TER of 0.49%. The ETC tracks the futures price performance of a range of storable commodities including gold (18.9%), copper (12.6%), natural gas (11.8%), Brent crude (11.5%), and WTI crude (10.4%).

An alternative is the UBS CMCI ex-Agriculture UCITS ETF (LON: CXAU) which has $179m in AUM and a TER of 0.37%. Top exposures include aluminium (13.3%), copper (12.9%), Brent crude (11.0%), light crude (10.1%) and gold (8.4%).

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