Three years on from the beginning of the cost of living crisis, we assess which investments have helped consumers beat inflation, and which have left their savings trailing in its wake.
- The average Cash ISA has made a negative real return over three years, despite rising interest rates
- Gold has bested Bitcoin as an inflation-hedge over the period
- Bonds have tanked, badly affecting those approaching retirement in annuity-hedging funds
- A shock result: UK Equity Income funds have beaten Global funds and Technology funds
- Smaller companies are down but not out
Laith Khalaf, head of investment analysis at AJ Bell, comments:
“In August 2021, the inflationary crisis began to take off with CPI jumping to 3.2%, up from 2% in July of that year. Consumer price inflation then climbed all the way up to a peak of 11.1% in October 2022 before gradually, and painfully, falling back to current levels. The latest inflation figure crept up a touch to 2.2%, but this is well within normal levels of variation around the target and was also accompanied by falling core inflation.
“Three years on from the beginning of the cost of living crisis, the scars still haven’t healed, but the worst is now firmly in the rear-view mirror. The inflationary crisis had a profound effect on the savings and investment landscape, prompting rising interest rates and a sell-off in previously unassailable parts of the market, in particular bonds and technology stocks. Looking back on performance over the last three years since the cost of living crisis began it’s clear that some investments have helped investors grow their wealth in the face of rising inflation, while others have capitulated in its presence.”
Investment returns over the last three years
Source: AJ Bell, Bank of England, FE, ONS, Cointelegraph. Total return in GBP to 12 August 2024, CPI and cash returns to July 2024.
Gold and Bitcoin
“Gold has made good on its promise as an inflationary hedge over the last three years, carving out a healthy real return for investors (see table above). That’s despite rising interest rates, which should in theory take the shine off the precious metal. The economic and geopolitical uncertainty of recent years has helped propel gold upwards. But it’s actually been central banks behind the buying action, with gold ETFs seeing a number of years of outflows. ETF redemptions may be a result of investors getting lured away by cash, and bonds now yields don’t start with a zero. Meanwhile central banks have been attracted to gold because it’s liquid, carries no credit risk, and is free from any geopolitical interference.
“Gold has also trumped Bitcoin over the last three years. While some may view Bitcoin as a store of value or an inflation hedge, the wild swings in the price of the cryptocurrency suggest it can’t be relied on to fill either role. In the short term, the US presidential election may exert a gravitational pull on Bitcoin now Donald Trump has thrown his weight behind crypto and promised the attendees of the Bitcoin 2024 conference that he would fire the head of the SEC on day one of his presidential term. The longer-term investment case for Bitcoin relies on it being adopted by consumers, businesses and investors, which is still a highly speculative snapshot of the future.
“While the cryptocurrency is currently enjoying one of its periodic moments in the sun, as surely as night follows day it will suffer another significant downturn at some point. Whether investors make any money in the meantime depends entirely on their timing, a precarious dynamic by any stretch of the imagination. Research compiled by the Bank of International Settlements estimates that around three quarters of Bitcoin buyers between 2015-2022 were likely to have lost money, despite a huge rise in the price of the cryptocurrency over that period. That’s almost certainly because they got sucked in at precisely the wrong time. However, looking back to before Bitcoin hit the mainstream, the returns have been other worldly for very early backers. £10,000 invested 10 years ago would now be worth over £1 million in real terms.
“As ever gold remains worthy of consideration as a portfolio diversifier because it behaves differently to other asset classes, but it shouldn’t make up more than 5 to 10% of your portfolio at most. While gold is known as a safe haven, it is volatile, and despite having a reputation for being an inflation hedge, it has endured long periods of below inflation returns. Meanwhile those who wish to hold Bitcoin should do so with only a small amount of money which they are willing to lose in its entirety.”
Cash and gilts
“It will perhaps come as a shock to learn that against a backdrop of rising interest rates, the average Cash ISA has registered a negative real return of -12.0% over the last three years, meaning £10,000 saved would now be worth £8,802 after accounting for inflation (see table above). That’s partly because cash rates have only risen gradually, and partly because not all accounts are offering competitive rates. Inflation has also provided a high bar in the last three years, which even the most competitive current rates wouldn’t have hurdled. Now inflation has become more temperate the best cash rates are offering an inflation-beating rate of return, but for long-term holdings savers are likely to get a better return from the stock market. Data from Barclays shows that over a 10 year holding period, UK stocks have beaten cash over 90% of the time.
“Gilt investors were some of the biggest losers from the inflationary spiral. Low interest rates and QE pushed up government bond prices for over a decade, priming the gilt market for a big spill. In 2010 the bond guru Bill Gross said the UK gilt market was resting on a ‘bed of nitroglycerine’. Twelve years later, he was belatedly proved right. In real terms gilts have lost over a third of their value in the last three years. This has had knock on effects on diversified strategies that invest in gilts such as 60-40 funds or mixed asset funds more generally.
“The pain has been particularly acute and untimely for those approaching retirement in lifestyled pension schemes, which hedge against annuity rate movements by investing in long-dated bonds. The typical annuity-hedging fund has lost almost half its value in real terms over the last three years, with £10,000 invested now being worth £6,306, or £5,246 after accounting for inflation. Annuity rates have risen by a similar amount but that’s cold comfort if, like 90% of retirees, you’re not buying an annuity with your pension pot.”
Global and UK shares
“Both the global and domestic stock market have managed to stay ahead of inflation over the last three years, which given soaring price rises is no mean feat (see table above). The FTSE 100 in particular has stood up well, and its performance is in line with the global stock market. This isn’t an entirely congruous result seeing as the UK stock market has been a laggard on the international stage for a while now, but the inflationary nature of the last three years has actually helped large cap UK stocks regather some lost ground.
“That’s partly because the FTSE 100 contains a large dollop of oil and gas companies, which have benefitted from higher energy prices. On top of this, banks have seen their net interest margins rise as base rate has climbed. The FTSE 100 also has more jam today stocks which prospered in the market rotation that took place when inflation started its ascent, eroding the value of more distant cashflows and the appeal of jam tomorrow companies. The recent AI-fuelled technology boom has banished memories of 2022, when the S&P 500 fell by 8% in sterling terms while the FTSE 100 eked out a 4.7% return – an uncharacteristically favourable performance wedge for the UK stock market.”
Best and worst performing individual shares
“The jam today trend is visible in the best performing individual shares in the FTSE 100 over the last three years (see table below). The top of the table is dominated by what might compassionately be called old economy chuggers. Beyond macroeconomic trends there are also some stock specific recovery stories in here in the form of Rolls-Royce and Marks & Spencer. The bottom of the table is more of a motley crew of fallen growth angels (JD Sports, Burberry), macroeconomic casualties (Persimmon, EasyJet) and stock valuations being pared back after a dizzying ascent (Scottish Mortgage, Spirax).”
Source: AJ Bell, Sharepad. Total return in GBP to 12 August 2024.
Fund sectors
“Only a clutch of fund sectors have provided investors with cushioning against inflation over the last 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 last three years (the latter has returned 5.6% compared to 16.0% 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 last 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 last 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 last 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 gilt 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. Consequently during the inflationary crisis, linkers were absolute stinkers.
“UK Smaller Companies have performed poorly over the last 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 last 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).”
