What caught my eye this week.

Finally my co-blogger The Accumulator has won the acclaim he so richly deserves.

No, not a plaudit for achieving the most active puns in a passive post.

Not the Leo Tolstoy Award for Services to Word Counts Beyond The Call of Anything Reasonable But Rather Really Excessive Haven’t You Even Heard of Twitter 2021 Edition.

Not even a retrospective of his black and white cartoons at the V&A.

But rather, a notification from The Motley Fool’s All-Star Money to tell us The Accumulator had won their article of the week spot with his Fighting The FIRE Demons post.

And the prize?

This artist’s impression of The Accumulator in bobblehead form:

Now, given how The Accumulator has cultivated an air of anonymous mystery around these parts, you might wonder why we’re so ready to share this homunculus with you all?

And the answer is you’re more likely to see The Accumulator doubling down on a triple-levered ETF than rocking a tie.

Meanwhile that wodge of cash would be out of his hands and invested into a long-term tracker fund before you could say, “I’ve worked out the terminal value of my round compounded in VRWL for 25 years and on reflection I’m sure I can hear my bus pulling up outside.”

And while TA is just as devilishly handsome as Bobblehead TA, our man is also older, more careworn, and about as likely to grin as Boris Johnson announcing a third wave.

In short, anonymity is preserved!

Nevertheless, it’s a wonderful treat from the All-Star Money team – thank you guys – and the least TA deserves after a decade of peerless posts for Monevator.

Just so long as he doesn’t expect a pay rise.

Have a great weekend everyone!

[continue reading…]

Signs of higher inflation abound. Beating inflation to preserve spending power is therefore high in many investors’ minds.

Bank of England chief economist Andy Haldane chimed in just this week, reports Reuters:

“If wages and prices begin a game of leapfrog, we will get the sort of wage-price spiral familiar from the 1970s and 1980s,” Haldane said, adding that inflation would not be on the same scale as in those decades.

In an interview with LBC radio earlier on Wednesday, Haldane said inflation pressure in Britain was looking “pretty punchy”.

9 June 2021, Reuters

Of course, predictions of higher inflation rival England’s football team for hype versus reality.

Surging inflation and English football glory have both been notably absent for many decades.

Inflation’s coming home

Indeed, one way to preserve the real value of your pound would have been to bet against England at every major tournament in my lifetime.

You’d probably have multiplied your initial stake nicely by betting that way – and reinvesting the proceeds each time. ¹

Betting against England might be a way of beating inflation.

However nobody sensible would say betting for or against England was a way of hedging against inflation.

While I haven’t earned a PhD crunching the numbers, England’s footballing performance surely has no correlation with inflation.

A sports team – and hence your bet – will win or lose irrespective of the inflation rate, in other words.

Whereas a hedge against inflation would be expected to protect against a decline in the spending power of your money due to rising prices.

Multiplying money via a wager – and so getting more spending power, beating inflation – doesn’t mean you actually hedged against inflation.

Beating inflation with a Banksy

So far so obvious – albeit dispiriting for England fans.

Yet the same confusion between beating inflation and hedging against inflation appears often in the investment world.

Right now asset managers are marketing their products as inflation hedges.

Here’s an advert I saw on Facebook under the banner: “Want a hedge against inflation? Invest in art today.”

Who wouldn’t want a 16,347% return over 13 years? Sign me up!

Actually, not so fast.

On these numbers, this (unnamed) piece of art would have been a fabulous investment.

But the advert tells us nothing about whether art is good for hedging against inflation, as opposed to beating inflation.

True, the 16,347% return equates to almost 50% a year on a simple annualized basis. Unless you’re getting clobbered hyperinflation, a 50% return a year will surely do a good job of beating inflation.

It would also turn anyone with a few paintings in their attic into multi-millionaires.

But I’m highly skeptical that anyone should expect a typical piece of art to go up in value near-50% a year over the next 13 years.

Annual returns around the 7-8% range from art are more typical what I’ve seen touted.

Yet even if your art choice did so well, I’d congratulate you on your luck or a great eye – but not necessarily on your choice of an inflation hedge.

At least not just because its price went up a lot.

To view art as an inflation hedge, we’d need a thesis as to why art should hedge against inflation (easy – real assets tend to go up over time, with inflation) and data showing correlation (I’ve never seen that for art).

Equities have a record of beating inflation

What about shares? Many people – me included – tend to think of equities as protecting against inflation.

We have our reasons. Companies can lift prices in response to inflationary pressure. They often own real assets such as land and property. Over time profits and dividends can rise – in contrast to bonds with fixed coupons. All of this means share prices can rise in the face of higher inflation.

However the authors of the Credit Suisse Equity Yearbook refute this notion.

The renowned academics divided equity and bond returns into buckets representing different inflationary regimes – from marked deflation through stable prices to very high inflation – as follows:

Their work shows the return from bonds varies inversely with inflation. At times of deflation (left-hand side) bonds do very well. They get smashed by high inflation (right-hand side).

Equities do much better than bonds most of the time – the exception being times of extreme deflation.

But real returns from equities are negative with very high inflation, although they still beat bonds.

We can’t really call equities an inflation hedge then. Not when their real return falls with high inflation!

The professors note:

These results suggest that the correlation between real equity returns and inflation is negative.

i.e. equities have been a poor hedge against inflation.

There is extensive literature which backs this up. Fama and Schwert (1977), Fama (1981), and Boudoukh and Richardson (1993) are the three classic papers.

Credit Suisse Equity Yearbook, 2021

If this fact is so accepted in academic circles, why do we think of owning equities in the face of rising inflation?

It’s because the returns from equities have a strong record of beating inflation over the long-term.

Shares do not hedge against inflation. But the magnitude of their out-performance versus other assets means over many decades and cycles they’ve typically delivered the best returns, easily beating inflation.

What assets really hedge against inflation?

Generally you want to own real assets – ‘stuff’ – when inflation takes off, if you want to hedge against inflation.

After all, inflation in part expresses how the price of stuff is changing. ²

The following from Bank of America (via Trustnet) shows such correlations:

Most things are positively correlated to inflation over the long-term.

Even cash! (That’s because interest rates tend to rise as inflation rises.)

The big exception is long-term government bonds. These are negatively correlated.

If inflation heads a lot higher then you’d look at returns from long-term bonds through your fingers. From behind the sofa.

Note the image shows correlations, not past or future returns.

The price of platinum is strongly positively correlated to inflation. That doesn’t mean platinum will necessarily be a brilliant investment.

Picking your poison in 2021

The best hedge against inflation are products designed for that purpose.

Index-linked government bonds, perhaps a basket of inflation-linked corporate bonds, or NS&I index-linked certificates.

However index-linked bonds are very expensive today. They are vulnerable to interest rate rises.

Corporate bonds introduce credit risk.

As for NS&I certificates, they aren’t even available to new investors. They also pay a pathetically low real return to those who already own them.

You’ll be hedged against inflation with NS&I index-linked certificates for sure. But you’re guaranteed to only just beat it…

Beyond that – and set against everything I’ve written above – I believe most of us should concentrate more on beating inflation than hedging against it. For a private investor with real world spending concerns, the long-term outcome is more important than the short-term correlations.

For most of us that means a healthy allocation to assets like equities and property – and crossing our fingers that we don’t face 20 years of stagflation. (You might want to own some gold in case of that).

Given how strongly correlated bonds are to inflation – they will surely do badly when inflation is running hot – you could argue holding fewer in a portfolio is also an effective way to dial down inflation risk.

However the more you reduce your government bonds, the more exposed you are to stock market falls – and also to deflation.

Beating inflation over the long-term

Finally, what do you know about inflation that the market doesn’t? It’s been constant media chatter for months now.

Someone somewhere is always warning of higher inflation.

I first saw that Bank of America forecasting imminent inflation – complete with an earlier version of its correlation image I included above – in the Financial Times in 2016.

And before that, at the start of QE I worried – like most people who didn’t work at the US Federal Reserve – about the inflationary consequences of monetary expansion.

Well it’s been 12 years and we’re still waiting!

Remember, if you’re working your income is likely to rise with inflation. Also if you own a house with a mortgage, over the medium-term inflation will probably push up prices while whittling down the real value of your debt.

Passive investors are probably best mostly sticking to a diversified portfolio, with a mix of assets aimed at beating inflation over the long-term, while also guarding against other scenarios.

If you want to gamble, punt on your national football team!

1. I’m assuming you’d earn a return on your stake between tournaments. And I haven’t done the maths! But given England hasn’t won anything since the 1960s I’m confident.[↩]
2. The other part is changes in the price of services.[↩]

Many in the Monevator community ask about how to manage multiple portfolios, especially as part of a single family household.

Reader Sunil sums up the dilemma:

I understand the importance of diversification, but what about across multiple portfolios?

I have a SIPP and ISA, and run a SIPP and ISA for my wife. That’s four portfolios.

I’m not sure it’s prudent to pick the same set of funds for each, or even the same kind of asset split across all four.

I find it incredibly difficult to decide across four portfolios. Add to that, both my kids now have ISAs – I might end up running six portfolios!

Any thoughts?

The standard advice is that different investment objectives are best handled by separate portfolios, each with their own asset allocation.

For instance it’s very likely that the goals for kids’ ISAs are quite different to that of the adults in a household.

The latter tend to be into boring stuff like retirement. Children less so!

One thing to rule all your multiple portfolios

When family members share an objective, the standard advice is to treat your various accounts as a single portfolio.

That keeps things simple – assuming you have joint finances.

With the single portfolio mindset, there’s no need to replicate your 5% gold allocation, say, across four different accounts. You can keep your gold fund in one place and so avoid multiplying your dealing fees per account.

This ‘notionally single portfolio’ approach helps with tax-planning, too.

For example, you could tilt towards equities in your ISAs, and bonds in your SIPPs, to avoid breaching the Lifetime Allowance on your pension.

To recap, the basic advice is:

• One family portfolio per shared investment objective
• Spread across multiple accounts as needs be
• Using a single asset allocation

I recommend keeping track of this gestalt portfolio with a tool like Morningstar’s Portfolio Manager.

The tax problem with multiple portfolios

That’s the standard advice, and it’s perfectly sound.

I came to regret it, however.

I ran the family Accumulator’s accounts as a single portfolio. We held different equity sub-asset classes in our SIPPs and all seemed well.

But one sub-portfolio did much better than the other. And so one now looks like the pumped-up arm of an Olympic javelin thrower. The other like a T-Rex’s puny forelimb.

Okay, the difference isn’t that extreme but one portfolio has certainly been much luckier than the other.

That’s because it holds the lion’s share of our US equities. And they’ve beaten the bejesus out of everything else.

As a consequence, we’ll have to drawdown harder on this over-performing portfolio.

A more even split of our bills would be more tax-efficient. Now we’ll pay more income tax as one SIPP portfolio tunnels more deeply than anticipated into a pricy tax bracket.

A richer family than ours could also trigger Lifetime Allowance events if one of their SIPPs was particularly over-stimulated.

If your SIPPs won’t dance on the borders of the tax bands then it won’t matter. But for anyone young-ish or rich-ish, that’s hard to predict.

It’s not just SIPPs

You could also face the same predicament if one family member’s General Investment Accounts bursts its tax-free banks excessively.

Theoretically this shouldn’t matter for stocks and shares ISAs because they’re tax-free.

Except they’re not quite… Because if you die (god forbid) then ISAs lose their tax shield – in the event that you pass them on to anyone except your spouse or civil partner.

That would include your unmarried partner, kids, or favourite pet gerbil.

In these cases your ISAs also fall into the Sarlaac Pit of inheritance tax. And hence they are no longer really tax-free.

ISA assets affect your eligibility for many mean-tested benefits, too, whereas pre-retirement assets sitting in a pension scheme do not.

Being caught out by any of these scenarios might leave you worse off as a family unit than if you’d just set up two mirror portfolios.

In retrospect, I wish I’d mirrored our respective holdings so we could spread the tax burden more evenly across our tax allowances.

Of course, mirror portfolios do double your dealing fees.

But you can dodge that hit by using multi-asset funds like Vanguard LifeStrategy, or at least minimise the impact by choosing simple two or three fund portfolios.

Platform collapse

Lopsided portfolios could also hurt if your investment platform / broker goes bust. Your assets are likely to be frozen while the administrator cleans up the mess.

What’s that? You had the foresight to open your partner’s accounts at a completely different platform that’s unaffected by the upheaval?

Okay, but sadly your broker was swept away in an economic tsunami that’s also wiped double-digits off your partner’s portfolio because the low-risk bonds were in your accounts.

And let’s say in this (hypothetical, somewhat extreme) example that it takes more than a year to unfreeze your assets.

Meanwhile, household bills surround you like kung-fu baddies. The only way to fend them off is by selling your partner’s equities when they’re down. Which is something that ideally you’d never want to do.

Granted, this is a low-probability scenario. But it’s one you can strike off your worry-list by maintaining a strong slug of low-risk assets in both partners’ portfolios.

Ask the Monevator massive

These may be edge cases but the standard advice doesn’t always apply when it collides with the quirks of the UK tax system. I had no idea The Accumulator family would be an edge case when we started out.

I’m interested to hear how the Monevator community manages multiple portfolios. Please let us know how your household handles this problem in the comments below.

Take it steady,

The Accumulator