Inflationary fears have been an intrinsic part of this summer’s investment narrative, with price increases across both the developed and developing economies. At a time when many advanced economies have almost ground to a halt, many investors are mesmerised by growth stories in emerging markets. But how much of the growth is eaten up by high inflation, and how should investors protect their clients’ wealth?

At the beginning of August, a survey by UK-based Baring Asset Management showed that more than three quarters of investors were worried about the impact of inflation on their cash investments. Nine out of ten of investors who took part in the survey said that their clients have already or plan to reallocate cash investment to inflation-protected assets.

“In terms of debt and indeed all investment, when you make your long-term asset allocation, I would say that inflation is the biggest consideration because over time it erodes the buying power of income,” Andrew Herberts, investment director and in charge of the investment strategies at Adam & Co, the UK private bank, told Wealthbriefing.

Some investors are stocking up on gold as a bulwark and the price of the precious metal climbed over $1,900 an ounce on Monday, representing an increase of 15 per cent this month. Other firms have highlighted inflation-resistant stocks. For example, experts from Fidelity International last month presented a selection of companies with enough pricing power to thrive in the inflationary environment, including tobacco company Swedish Match and luxury brand Burberry.

“It’s always good to have diversified assets, metals included,” Scott Patten, chief operating officer and partner at AU & Associates, a New York-based family office, told this publication. “For us in the US it makes sense to hold gold, because the US dollar is in decline and we believe it will continue to decline in the future.”

Multinationals and oil

Equities are often seen as the best way to hedge against inflation in the long term. “Some domestic large cap stocks offer good yield of about 4 to 6 per cent, which works as a cushion but also provides good growth potential,” Patten said. “The euro and the dollar have slid to some degree, which means that multinational offers good opportunities at the moment.”

Patten also singled out Oil Master Limited Partnerships as an attractive investment in the US, as the price of oil has taken a 20 per cent hit and energy demand continues to grow. Moreover, he emphasised high yields and favourable tax treatments, and the fact that there are very few alternatives to oil.

“In this environment, no fixed income is going to serve you brilliantly,” Herberts said. “We do have some emerging market debt, and it still gives you a better yield than developed market debt. South Korea is one example that offers attractive government bonds. We’re trying to avoid the likes of China and India.”

July’s consumer price index in South Korea was 4.7 per cent, up from 4.4 per cent in June. Core inflation, which excludes volatile items such as energy and food products, stood at 3.8 per cent.

Safe havens in the developing world

There are those who are still keen on emerging market debt: “We remain constructive and positive about local bonds in emerging markets,”Thanasis Petronikolos, head of emerging market debt at Barings, told Wealthbriefing. “It is true that we so far this year have seen increasing inflation, but it is mainly due to a rise in food prices which causes high headline inflation. Core inflation has been much lower. For example, in China headline inflation is 6.5 per cent but only 2.9 per cent when food prices are excluded.

“We believe that inflationary pressures are weakening and that China will fall below 5 per cent by the end of the year. Brazil, which has 6.9 per cent, will fall towards 6 per cent by the end of the year. It is still quite high but it is falling and it will continue to fall in 2012, as the world economy is slowing down, but also because interest rates are at 12.5 per cent in Brazil.

“In Latin America, inflationary pressures have been subdued. I would recommend Mexican bonds, but not just for that reason. They have been one of our overweight positions and performed well in the last month.”

Mexico’s latest CPI reading stood at of 3.3 per cent, according to the central bank, marginally lower than a year ago. The producer price index, which some argue is a more relevant way of measuring inflation, was 3.55 per cent.

“In Eastern Europe, inflationary pressures are modest in Hungary and it has one of the best inflationary outlooks in the region. First, because of what’s happening in Europe, but also because interests are quite high (6 per cent).”

In Hungary, the annual CPI rate of 3.1 per cent in July was lower than 3.5 per in the previous month and close to the central bank’s target of 3 per cent.

“In Asia, I would look at Malaysia and Taiwan. Many Asian currencies are undervalued and they have the option to appreciate, which is another way to control inflation and another argument in favour of local bonds,” he said.

Malaysia had a headline inflation rate of 3.5 per cent in June, according to the central bank. In Taiwan, the rate slowed from 1.9 per in June cent to 1.3 per in July.

Not the biggest threat on the radar

Petronikolos concluded that Barings is not concerned about inflation and that his team sees a greater risk on the growth side. However, he emphasised that investors who are concerned have the option to buy inflation-linked bonds. “In that case, I would recommend buying inflation-linked bonds in Turkey and Poland, because they are better priced than the ones in Latin America,” he said. “We do have some inflation-linked bonds, but not many because they don’t offer attractive entry-points.”

“Inflation-linked bonds are a compelling place to be at the right price and the right time, like in 2009,” Herberts said. “Under the right circumstances, they offer proper protection against inflation. But they are expensive at the moment; most fixed income is fairly fully valued.”

Most experts believe that we will see waning inflationary pressures across the board next year, as the world economy is slowing and demand will ease off. Ben May, European economist at Capital Economics, a macro-economic research consultancy, pointed out that some of the countries that are now boosting low inflation in Europe, such as Sweden and Switzerland, might see higher rates in the next couple of years. “We expect eurozone CPI inflation to average around 1.5 per cent next year and 0.5 per cent in 2013,” he said. “Unless their currencies continue to appreciate sharply, stronger economic recoveries in Sweden and Switzerland mean that inflation in both economies may be higher than in the eurozone in 2013.”

“High inflation has been part of the story so far this year; over the next two years, we believe that growth will be a much bigger concern,” Neil Shearing, emerging market economist at Capital Economics, told this publication. “If you ask investors if they are worried about inflation next month, I think you will get a very different story.”