Fund tips to battle inflation

But not everyone is convinced, and the overwhelming prediction is that 2011 is likely to see diverging inflation trends. In the developed world, low growth coupled with loose monetary policy is likely to keep inflation at moderate levels. In contrast, the combination of strong domestic growth, food price inflation, currency intervention and QE in the West is likely to drive up inflation in emerging markets.

"Higher emerging-market inflation is a key risk and investors should get some protection via inflation-linkers while it's still affordable," says Philip Poole, global head of macro and investment strategy at HSBC Global Asset Management.

In response to concerns over inflationary pressures building up in the emerging economies, Percival Stanion, head of asset allocation at Baring Asset Management, is seeking inflation protection in agriculture-related equities while also increasing exposure to the property sector, gold bullion and other real assets.

However, Tim Cockerill of Ashcourt Rowan Asset Management points out that according to recent work done by the International Monetary Fund (IMF), few assets tend to offer good protection when there is an inflation shock. "A bond, sovereign or corporate, whose return is linked to inflation is the best certain protection you can get," he comments. "Gold and other commodities can also work well but they do not have a 'guarantee' of inflation proofing. Equities can offer protection too, but it depends on the level of inflation and the type of equity."

■ Fund Tips:

Cautious: M&G UK Inflation-Linked Corporate Bond Fund

Launched in September this year as "the first of its kind" the M&G UK Inflation Linked Corporate Bond Fund invests primarily in investment-grade UK inflation-linked corporate bonds and other fixed-interest securities that should perform well when inflation is high or rising. The fund is managed jointly by Jim Leaviss, head of M&G's retail fixed interest team, and Ben Lord, fund manager. Mr Leaviss says that while inflation will remain above target at a headline level, falling core inflationary pressures may prompt a renewed bout of quantitative easing QE) in the UK.

Given the fact that no one fully understands the impact of QE and record low interest rates, investors will remain concerned about the resurgence of inflation. This fund is a good 'sleep at night' investment which should provide a better return than sovereign inflation-linked bonds.

Aggressive: ETFS Physical Gold

M&G's Inflation-linked Corporate Bond Fund might offer protection if inflation returns to the UK but what about the more persistent threat of inflation flaring up in the emerging markets? An increasing amount of investors now hold exposure to emerging markets.

Real assets (those with intrinsic value) such as gold, agriculture, commodities and property have tended to be the best protectors against the wealth-eroding effects of inflation. Of these, gold is a firm favourite. While you can invest in gold via a fund which invests in the shares of gold mining companies, such as the BlackRock Gold and General or Investec Global Gold Fund, an exchange-traded fund (ETF) that is backed by physical gold bullion, such as ETFS Physical Gold, will allow you to track the spot price of gold at much lower cost.