Commodities, TIPS and cash can partially hedge short-term fluctuations in inflation while equities have consistently outperformed other assets for a longer holding period. Our analysis shows that no single asset constitutes a perfect inflation hedge. Inflation hedge effectiveness depends on the correlation between an asset’s return and inflation, inflation beta sensitivity and the holding period. It is important to take these factors into account before deciding where to invest.
Head of Quantitative Research and Analysis, SPDR ETF Model Portfolio Solutions, EMEA & APAC
As the global economy emerges from one of the worst shocks since the Great Depression, triggered by the COVID pandemic, investors have once again started to refocus their attention on inflation and its possible trajectory. Recent inflation surprises have only heightened concerns; although, industry commentators generally agree that these surprises are transitory in nature and will only have an ephemeral impact on economic growth.
This view, which State Street Global Advisors also shares, was aptly summarised in the recent Global Market Outlook, in which the authors noted that rising input costs and a strong rebound in global demand have been fuelling inflation. While current spikes should moderate later in the year, inflation is expected to remain at elevated levels over the next two years.1 That being said, the authors also conceded that a key risk to their forecasts is sustained higher inflation. This uncertainty has led some investors to re-evaluate the assets that could help mitigate the potentially negative impact of inflation on investment returns. Inflation is often a key consideration for investors, with the objectives of many investment portfolios directly anchored to inflation rates.
Given the importance of inflation considerations, we have carried out a detailed analysis on how investors can protect against inflation. In this paper, we investigate whether inflation risk can be attenuated through investing in a variety of common, publicly traded investment exposures. Our investigation is built upon the previous work undertaken by researchers at the IMF who utilised inflation beta as the primary statistical measure to appraise the inflation-hedging capabilities of an array of investment exposures.
To extend their work, we have repeated the same analysis using more recent data with a focus on the US, scrutinised the historical performance of these assets under different headline inflationary regimes, and studied whether their performance covaried with expected and unexpected inflation, both of which are estimated from the headline inflation figures via a statistical technique. Finally, we also considered the potential impact on investment exposures from headline inflation shocks, which are defined as a one standard deviation move.
The investment implications of the analysis in the paper are summarised as follows:
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