Bonds are once again offering attractive yields, but are they enough to offset inflation? Darius McDermott – managing director of Chelsea Financial Services, highlights other income options investors may want to consider.
Last month’s inflation data came in at 3.5%*, and expectations are that it will top 4% in the coming months. Significant inflationary pressures remain embedded in the system.
It’s not just oil prices: this week saw the British Retail Consortium warn that the ‘dam is starting to break on the huge wave of costs’. It is a grim reminder that your investment income needs to outpace inflation.
Thanks to rising government bond yields, income is increasingly abundant. Any investor wanting a nice income these days could do worse than simply buying a government bond.
A UK 10-year gilt yields around 5.3%, while 10-year US treasuries yield just below 5%**. The UK and US (probably) won’t go bust, though some other countries – we’re looking at you, France – don’t appear quite the safe bet they once were.
However, the trouble with bonds is that they provide limited protection from inflation. Admittedly, a 5.3% yield gives some wiggle room over 4% inflation, but bond prices are still likely to drop if inflation surges.
Investors need to consider where they can build greater inflation protection in their portfolios.
What are the alternatives?
Superficially, equity income doesn’t look as appealing as it once did. It’s not that long ago that stock markets were yielding more than bond markets.
That makes the income available from even a high dividend market, such as the UK, look relatively lower. The FTSE All Share yield currently sits at just over 3%***, some way behind the 5%+ yields available on gilts.
But the income can grow. On a £10,000 investment, investors might only get £300 in the first year, but if that grows at a (relatively unambitious) 5% a year, investors are matching the income level of a gilt within a decade – and, importantly, with capital growth and further income potential on top.
Equally, dedicated income funds can deliver a higher yield. Artemis Income fund, for example, has a yield of 3.5%****. Manager Adrian Frost believes there are sound reasons why the portfolio can also deliver growth: “Portfolio companies are buying back shares equivalent to approximately 3% of their market capitalisation each year.
Dividends and buybacks combined therefore imply a cash return to shareholders of around 7% before allowing for any growth in earnings, dividends or cash flow.
“We also think there is an interesting opportunity for our companies to create value through M&A and industry consolidation. Higher interest rates have made this more challenging for private equity at a time when pressure is building to distribute capital to investors.
“This should create opportunities for well-capitalised strategic buyers to acquire attractive assets at sensible valuations. Informa’s latest acquisition is a good example.”
Other income funds also come with good growth prospects. Schroder Asian Income, for example, targets a payout of 3.5-4% per year.
Manager Richard Sennitt says: “We’re looking for companies with an income rational, but where there is an upside to capital values as well. When you look forward, the biggest driver of where yields are going to go is where are earnings going for our companies, which translates into dividends.
“Earnings for our companies have started to recover quite strongly. That should feed through into dividend growth going forward for the overall region.”
Similar to many Asian income funds, it doesn’t look like a traditional ‘income’ fund. Among its top holdings are AI-exposed giants TSMC, Samsung Electronics and Hon Hai Precision Industry. It has almost 30% in technology****.
Incorporating an Asian income option can bring in new sources of growth, alongside providing some inflation protection.
Infrastructure is another option for investors looking for this blend of income and growth. Infrastructure assets include toll roads, schools and hospitals built under public-private partnerships, plus power grids, utilities and airports.
They have regulated cash flows, usually with built-in price adjustments tied directly to the Consumer Price Index.
The TM Gravis UK Infrastructure Income fund, for example, has a yield target of over 5%, but has been paying a yield of over 6%****.
Importantly, that yield should grow at least in line with prices because there is explicit inflation linkage in many of the fund’s underlying infrastructure assets.
It owns a broad range of assets, including wind farms (through Greencoat UK Wind), healthcare assets (through Primary Health Properties) and warehousing (though Tritax Big Box REIT)****.
Manager William Argent says the recent inflation data has had a positive impact for many of the fund’s holdings: “Their cash flows are linked to inflation. What’s important is what they had baked into their expectations, and if inflation has run hotter. That has led to uptick in those revenue expectations.”
He says the sector has been benefiting from the ‘HALO’ trade since the start of this year. This idea focuses on companies with ‘Heavy Assets, Low Obsolescence’ which provide a counterbalance to the frothy and unpredictable AI trade.
Will says that companies in the fund have “high stable cash flows, the high barriers to entry, regulated frameworks, defensive cash flows, and tailwinds from government spending.” This makes them a good antidote to more speculative parts of the market.
In each of these cases, the inflation protection does not come at the expense of long-term capital growth. For the UK, dividend yields, low valuations and share buybacks are supporting long-term growth.
In Asia, technology innovation is driving stock market gains, while infrastructure is supported by long-term themes such as the build out of data centres or the energy transition. They may offer a better solution in the current climate than focusing purely on bonds for income.
*Source: Office for National Statistics, 21 October 2026
**Source: MarketWatch, 27 October 2026
***Source: London Stock Exchange, 27 October 2026
****Source: fund factsheet, 30 September 2026
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.
Main image: inflation, markus-winkler-GNuN-c94_aA-unsplash
