Three ways to play inflation through UK equities

As inflation figures for July top 4%, the manager of Fidelity's UK Aggressive Fund offers three ways to play rising prices through UK stock market investments.

Aruna Karunathilake has identified three different groups of companies which at the least are insulated against rising prices and at best present an opportunity for superior growth prospects.

"Inflation - or more precisely, people's perceptions that prices are rising much faster - is likely to cast its shadow over economies and markets for some time to come, " says Karunathilake. "Yet UK equity investors can not only protect themselves from higher prices, but also seek to profit from them."

1. Defensives: some companies either have revenues linked to inflation or have the ability to pass on higher rises to their customers. In the first group are the utilities: their regulatory regime ensures that growth of their revenues is tied to inflation, typically RPI (retail prices index) which is higher than CPI (consumer price index). These are the equity equivalent of index-linked bonds. National Grid, a top 10 holding, is a good example.

Also in this group are companies that have the power to pass on prices to consumers. Farmers are pushing up their prices to reflect the imbalance in supply and demand. The small number of supermarkets that dominate the British high-street can pass on these increases, leaving the less influential food producers to feel the squeeze. This is one of the reasons I have Tesco in my top 10 holdings.

2. Resources: the obvious way to play inflation because higher commodity prices are largely responsible for the increase in inflation. Whether we are talking about fuel or food, supply is unable to cope with surging demand from developing countries. Although the price of oil has fallen from its recent peaks, it is still 60% higher than this time last year. Royal Dutch Shell is my largest holding.

3. The second derivative: here I attempt to identify the less obvious beneficiaries of rising prices. An indirect way to play higher food prices is through the needs of farmers. Demand for fertilisers such as potash has soared along with grain and meat prices. It's not possible to gain exposure to fertiliser producers through the UK stock market, but using the overseas facility of this fund I have K&S, a German group.

Another indirect play is to look at those countries which benefit from higher resource prices. Nigeria, although it has a reputation for political instability, is a major exporter of crude oil and so is growing rich on the back of rising oil prices. PZ Cussons, probably best known to UK shoppers as the maker of Imperial Leather Soap, derives over 30% of its revenues and 12% of its profits from its Nigerian retail distribution business.