At first, most commentators were expecting short-term only transitory inflation in response to short-term drivers. But supply chain issues and the appalling events in Ukraine have seen the price of oil rise spectacularly and threaten the country’s grain and wheat exports, which make up ten per cent of the global total. The result is UK headline inflation now running at around seven per cent and expected to continue to rise further before easing at the earliest in late 2023.
The bad news is that boards are unlikely to get a huge amount of help from the Bank of England. Higher interest rates are usually used to combat higher inflation but can also slow economic growth. With the pandemic recovery still fragile, central banks are walking a tightrope. Expectations are for the bank to raise rates again this year from 0.5 per cent to around 1.75 per cent – higher than we’ve seen for some time but still well below the expected rate of inflation. Any cash sitting on deposit is likely to lose value in real terms this year and next.
There is no ‘correct’ level of cash for trusts to hold on deposit. Some reserves are needed to cover operating costs and planned capital expenditure, with perhaps a little extra for unforeseen costs. However, if any part of the overall reserve is not needed for a specific purpose in the near term, it is certainly worth considering whether the funds could work a bit harder to offset inflation.
Can the reserves work harder?
Considering a move that would see cash reserves reduced in favour of other investments should not be taken lightly. Placing capital at risk in the short term can lead to better returns in the long term, but the assets can also be subject to fluctuations in value along the way, which may not be suitable for all trusts. However, for those who can take a longer-term view with a proportion of their reserves, it could generate a better return than cash.
Investing does not mean that all of the assets are going to be exposed to the vagaries of stock market volatility. While some involvement might be appropriate as part of the overall structure of the portfolio, there are other asset classes that can offer protection against inflation, such as inflation-linked bonds, infrastructure, commodities and renewable energy. Selectively, company shares can also be appropriate, but investors should assess whether companies have ‘pricing power’ – the ability to put their prices up at least in line with inflation – because ultimately their profits should follow.
A thoughtfully constructed combination of these assets can provide well-diversified exposure to a number of underlying investments, which help to provide some protection against inflation.
Careful review of risk
Before proceeding with an investment, there should be a thorough review of the overall level of risk the board is prepared to accept. As every good investment manager will tell you, the value of investments can go down as well as up, and it is important to understand what impact this may have on the overall financial position of the trust.
But the fact is that inflation is back with a vengeance, and it looks like it will be with us for some time. The sooner boards consider its implications and what they might be able to do to offset its effects, the better positioned they will be to deal with it.
In an environment where it is crucial to make the most of reserves, it is nothing more than due diligence to explore opportunities for investment, even if the ultimate decision is not to pursue it.
The value of investments and any income from them can fall, and you may get back less than you invested. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, and opinions expressed in this publication are not necessarily the views held throughout Brewin Dolphin Ltd.