Which funds outperformed high inflation?

Inflation started to rise three years ago, firing the starting gun on the cost of living crisis. In August 2021 the CPI measure of inflation jumped to 3.2%, up from 2% in July of that year, before hitting a peak of 11.1% in October 2022. It has since dropped to 2.2% at the latest reading. But which funds and sectors fared best during that high inflation time? We’ve already looked at asset classes and individual stocks (read more about these here) but how did fund sectors fare?

Only a clutch of fund sectors have provided investors with cushioning against inflation over the past three years (see table below). Indian stocks probably wouldn’t be your first choice to withstand an energy crisis, seeing as the country is such a large oil importer. However, the Indian stock market has boomed in recent years, driven by high levels of economic growth, greater retail participation, and the declining fortunes of the Chinese economy, which has prompted investors to seek out a more compelling emerging markets growth play. Indeed, Chinese funds sit at the very bottom of the fund sector performance table thanks to such weak investor confidence. Commodity and natural resources funds have also prospered over the period, which stands to reason in a global inflationary crisis.

One perhaps surprising result is that the average UK Equity Income fund has performed better than the typical Technology fund or the Global fund sector. A large chunk of UK dividends emanate from the energy sector, and this exposure has afforded some protection to investors during the inflationary crisis. Indeed, the UK Equity Income sector has outperformed the broader UK All Companies sector by 10 percentage points over the past three years (the latter has returned 5.6% compared to 16% from the UK Equity Income sector).

UK Equity Income funds tend to have a larger cap focus than UK All Companies funds, which prefer to go hunting in mid and small caps – areas which have performed well over the long term, but not the past three years. It’s worth noting that despite its relative success, the UK Equity Income sector has still not quite managed to produce a positive real return over the past three years.

Source: AJ Bell, FE, ONS. Total return in GBP to 12 August 2024.

Bond fund sectors constitute a lot of the bottom of the performance table. Inflation created havoc in bond markets over the past three years, not least because bond prices had been pumped up to extortionate levels by loose monetary policy over the previous decade. The maturity profile of UK government bonds is longer than US or European counterparts, which is positive for the Exchequer when interest rates rise, but also means that bond prices fall harder. Hence why UK government bond sectors are bringing up the rear, which will have been particularly keenly felt by investors who normally seek out these safe havens as part of a cautious investment strategy.

It might come as a surprise to find UK Index-Linked Government bond funds performing terribly during an inflationary crisis, because the capital and income from these bonds rises with inflation. But this segment of the market contains even longer dated bonds than the conventional gilt bucket, and prices are likewise sensitive to rising interest rates.

UK Smaller Companies have performed poorly over the past three years, partly a reaction to a strong bull run in 2020 and 2021, but also a reflection of weak economic conditions and a dampening of risk appetite. Billions of pounds being pulled out of UK funds year in year out since 2016 hasn’t helped. But many Smaller Companies managers are now chomping at the bit based on the opportunities they are seeing in the market at current prices.

Longer-term investors in smaller companies will know first-hand the wealth creation power that can be delivered by this market, especially when combined with proficient active management. Over the past 10 years the average UK Smaller Companies fund has returned 91.4% compared to 70.5% from the typical UK All Companies fund. Over 20 years the average UK Smaller Companies fund has returned 446.0%, compared to 287.4% from the average UK All Companies fund (source: FE total return to 12 August 2024).

These articles are for information purposes only and are not a personal recommendation or advice. Past performance is not a guide to future performance and some investments need to be held for the long term.