The Threat: What Does ‘Higher for Longer’ Inflation Mean?

The Bank of England’s 2% target remains the goal, but economic forecasts for 2026 are highly uncertain. Even if the inflation rate falls significantly, the cumulative effect of the last few years means prices are already substantially higher.

Inflation is a “negative real return”: If an investment delivers a 4% nominal return, but the UK Consumer Price Index (CPI) runs at 3.5%, your real return (the increase in purchasing power) is only $4\% – 3.5\% = 0.5\%$. If inflation hits 5%, your real return is negative, and your money is actively losing value, regardless of the positive number on your statement.

The current challenge is unique: high inflation is combining with higher interest rates, which causes volatility across traditional assets like bonds, making the search for a safe inflation hedge more complex.

Building the Inflation-Resistant Portfolio: Key Asset Classes

An effective inflation-hedging strategy involves strategically allocating capital to assets whose returns are positively correlated with rising prices or which possess inherent protection mechanisms.

1. Index-Linked Gilts (The Direct Hedge)

UK Index-Linked Gilts (ILGs) are bonds issued by the Government whose coupon payments and final redemption value are explicitly linked to an inflation measure, typically the Retail Price Index (RPI).

• How They Work: When inflation rises, the principal value of the gilt increases, and the interest payments (coupons) are calculated on this inflated principal, offering a direct, contractual hedge against rising prices (Source: IG, November 2025).
• The Trade-Off: While highly effective at hedging against unexpected inflation, ILGs can be complex and are highly sensitive to changes in real interest rates (the interest rate minus inflation). They also carry lower expected real returns than equities over the very long term. They are generally considered a conservative core holding for preserving real capital, particularly for those approaching retirement.

2. Equities (The Long-Term Hedge)

Over the long run, equities (shares in companies) are one of the most reliable inflation hedges because companies have the ability to pass rising costs on to consumers through price increases.

• Pricing Power: Focus on companies and sectors with strong pricing power. These are businesses that offer essential goods or services or have such a dominant brand that they can raise prices without a significant drop in demand. Examples include:
  • Consumer Staples (essential household goods).
  • Healthcare and Pharmaceuticals.
  • Infrastructure (utility companies, toll roads) which often have contracts with inflation-linked revenue streams built in (Source: Charles Stanley, July 2025).
• Value vs. Growth: In inflationary environments, Value Stocks (companies with robust current earnings) often outperform Growth Stocks (companies whose returns are heavily discounted from future, uncertain earnings), as inflation makes those future returns less valuable in today’s money.

3. Real Assets (The Tangible Hedge)

Real assets are physical, tangible investments that tend to appreciate in value when paper money (like the pound) depreciates.

• Real Estate (via REITs): Real Estate Investment Trusts (REITs) allow investors to gain exposure to property without the hassle of direct ownership. Both property values and rental income tend to increase with inflation, making REITs a resilient, liquid option for adding a property element to a portfolio.
• Commodities: Gold is the classic safe-haven asset, offering non-correlated returns that tend to surge during periods of geopolitical uncertainty and high inflation. Other Commodities (energy, industrial metals, agriculture) are the raw materials whose rising prices cause inflation, making them effective hedges. A small allocation (typically single-digit percentage) to a diversified commodity basket or gold ETF can act as valuable portfolio insurance (Source: Price Mann, August 2025).

Excerpt: The Portfolio’s “Secret Weapon”

“The most potent, yet often overlooked, inflation protection mechanism available to UK investors is not a specific asset class—it’s the strategic use of tax wrappers. When you earn an investment return, a portion of that return is immediately lost to tax (Income Tax, Capital Gains Tax, or Dividend Tax).

In an inflationary environment, your net return is already fighting hard just to break even with the rising cost of living. By investing within a Stocks & Shares ISA or a Pension, every penny of your capital growth and income is shielded from UK taxation. This tax shield ensures that the entire (nominal) return is working to offset the inflation threat, effectively compounding your inflation defence strategy.

Maximising these allowances must be the foundational step before selecting a single inflation-hedging fund or stock.”

The UK Advisor Shift: From Inflation to Preservation

The low level of research into inflation protection among UK advisors, as highlighted by recent reports, points to a focus on immediate market risk rather than long-term purchasing power risk.

• Capital Preservation: Interest in ‘capital preservation’ strategies has risen significantly (Source: Titan Square Mile, November 2025). This is a cautious, defensive stance aimed at minimising losses during a market downturn, often by moving into lower-risk bonds or multi-asset funds.
• The Risk of Over-Caution: While understandable, an excessive shift to cash and low-growth capital preservation assets leaves investors highly exposed to the silent erosion of inflation. If inflation remains at 3.5% and a “safe” fund returns 2%, the client is losing 1.5% in real terms every year.

The true role of the financial advisor in the current climate is to bridge this gap: adopting a cautious approach to market risk while ensuring that the portion of the portfolio earmarked for growth is genuinely equipped to outpace inflation over a multi-year horizon.

💡 Practical Steps to Inflation-Proof Your Portfolio

1. Review Real Return: In your next portfolio review, ask your financial advisor specifically what the real return (return after inflation and fees) of your portfolio has been over the last three years.
2. Stress Test Your Drawdown: If you are in retirement (or approaching it), check if your drawdown strategy is modelled to withstand a long period where inflation runs 1.5% to 2% above the Bank of England’s 2% target.
3. Maximise Tax Wrappers: Utilise your current year’s £20,000 ISA allowance and ensure pension contributions are topped up, especially before the tax year-end, to benefit from tax-free growth—the ultimate long-term inflation shield.
4. Check for Diversification: Ensure your portfolio is not overly reliant on one asset class. Review allocations to Index-Linked Gilts, Commodities, and Infrastructure funds to introduce non-correlated hedges.