How to protect your direct lending portfolio against inflation

With the devaluation of the sterling and continuing low interest rates, it is likely that inflation will start to make an appearance again.  Inflation can decrease the value of your investment holdings over time.  There are three actions you can take to protect your direct lending portfolio against inflation, the most important of which is to spread your borrowing risks.

Experts continue to debate the long-term direction and nature of inflation in light of Brexit and the devaluation of sterling. However, an imminent increase in inflation is likely, as confirmed by the Chancellor in a recent interview with ITV ahead of Wednesday’s Autumn Statement.

“We have to wait and see what the inflation figures look like when we get the OBR’s report on Wednesday but I think, looking at the consensus of forecasts it is clear inflation is back, and that is hopefully a temporary phenomenon as the effect of Sterling’s decline feeds through the economy.” Philip Hammond

As the UK heads for a period of higher inflation coupled with falling GDP and stagnant wages, you can mitigate risk within your direct lending portfolio in three ways*:

  1. Diversify across asset classes: choosing a basket of borrower types to lend to reduces the risk that inflation bites harder in one particular asset class as opposed to another;
  2. Keep the average term of your portfolio less than a year: Long term lending (5+ years) is not very appealing at present and shorter duration loans means you can re-balanced pricing quickly or reallocate elsewhere once the nature of the inflation risk is known.
  3. Don't get greedy: now, more than ever, chasing the last few percent of returns (i.e. loans at 12%+) could come back to bite. The default risk curve is not linear, and it pays to be conservative during periods of low interest rates, as higher risk returns are most over-priced.

We will have a clearer picture after more after Wednesday’s Autumn Statement and the findings in the OBR report however, whatever direction inflation ends up taking and whether the rise is temporary as Hammond hopes, these three key actions should help you hedge against risk.  

*Warning: nothing in this article should be construed as advice.  Your capital is at risk

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