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3 easy ways to inflation-proof your investment portfolio

8 June 2021

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Inflation has been the talk of the town and sending jitters down investors’ spines.

 

Longer-duration assets like growth and technology stocks have especially come under pressure in recent months amid inflationary concerns, given prospects that higher rates might undercut future earnings potential. The information technology (IT) sector has also sharply underperformed the broader S&P 500 so far this year, reversing course after outperforming strongly in 2020.1

 

What is inflation?

Inflation measures the average price level of a basket of goods and services in an economy.
It is the increase in prices over a period where a specific amount of currency will be able to buy less than before.5

 

As the global economy reopens, individuals and businesses are likely to increase spending, which can lead to higher inflation in the near-term. Price surges have also come amid global supply bottlenecks caused by several factors, from semiconductor production issues to the soaring demand for a variety of commodities. The sharp increase in recent inflation data was also due to base effects – as inflation was very low this time last year when negative impacts of the pandemic hit the US economy – with year-over-year comparisons thereby to be distorted for months to come.2

 

Why should I be concerned?

US central bank, the Federal Reserve (the Fed), had in the past year engaged in a series of ultra-accommodative monetary policy measures to cope with the economic devastation that came with the pandemic. This largely came in the form of lower interest rates and asset purchases that arguably steered the US economy from undergoing a severe recession, and as the economy recovers and as inflation picks up, investors are paying close attention if excessive inflation could cause the Fed unwind its accommodative measures sooner than expected.

 

So far, Federal Reserve Chair Jerome Powell has said repeatedly he believes inflationary pressures this year will be "transitory", largely reflecting base effects as this year's data lap last year's pandemic-depressed levels. And for years previously, inflation ran well below the central bank's targeted levels.1 Fed officials have also repeatedly said they will not raise interest rates or pull back on monthly bond purchases until inflation averages around 2% over an extended period.2

 

Whether or not inflation actually becomes a major problem for the economy will only be known in hindsight. While most experts expect inflation pressures to be temporary3, it may be a good idea to diversify your investments across different types of inflation-resistant assets and asset classes such as inflation-linked bonds and alternative investments like real estate and commodities.

 

Here, we outline 3 simple ways you can inflation-proof your portfolio.

 

1) Stocking up on value stocks

History shows that stocks beat inflation over the long run, even if costs continue to increase at a steady clip over the next few years. Yet, an area you may want to stay away from is growth stocks, or companies with higher-than-average expected earnings. Growth stocks tend to perform worse because they expect to earn the bulk of their cash flow in the future. And as inflation increases, those future cash flows are worth less.4 Examples of popular growth stocks include big technology companies like Facebook, Amazon, Apple, Netflix and Alphabet (formerly Google), also commonly referred to as the FAANG stocks. 

 

Value stocks, typically mature companies with stable dividend issuances, usually do better during inflationary periods. Examples include financial institutions the likes of Morgan Stanley, Wells Fargo or Berkshire Hathaway. That’s because these companies are often in industries, such as the financial and consumer staples sectors, that get hit lesser by inflation. These businesses tend to be well-established with superior pricing power that allows them to increase their prices with inflation better than other industries, allowing them to better keep up with inflation.4

 

2) Inflation-linked bonds

Traditional bonds tend to perform poorly in a rising inflation environment since their fixed, future payments are worth less if prices of goods and services are ticking higher. And because an interest rate hike by the Fed might be in store, experts recommend that you don’t tie up too much of your money now in any long-term bonds or certificates of deposits. Doing so could lead you to miss out on higher rates later.4

 

Inflation-linked bonds are indexed to inflation in order to explicitly protect investors from inflation and have principal and interest payments that rises and falls with the rate of inflation. For example, the principal value of Treasury inflation-protected securities (TIPS), a type of U.S. Treasury bond, changes based on the inflation rate, therefore, the rate of return includes the adjusted principal.5

 

For exposure into inflation-linked bonds, explore the BlackRock Global Inflation Linked Bond Fund or PIMCO Global Real Return Fund. Search for it with our Fund Finder and filter your results by choosing the respective Fund Manager, i.e. BlackRock or PIMCO.

 

3) Alternatives as an alternative

Alternative investments such as real estate stocks and commodities can also be beneficial for your portfolio in a period of rising inflation.

 

Commodities are a broad category that includes grain, precious metals, electricity, oil, beef, orange juice, and natural gas, as well as foreign currencies, emissions, and other financial instruments.5 Fortunately, it's possible to broadly invest in commodities via unit trusts. Historically, commodities have performed well in periods of rising inflation. There’s also potential uplift from upcoming infrastructure plans within economic powerhouses like US and China.6

 

Property prices and rental income tend to rise when inflation rises.5 Real estate performs well because landlords and property owners see the values of their properties increase, and landlords can somewhat easily pass-through rent increases.4

 

To access commodity or real estate funds on dollarDEX, check “Commodity” or “Real Estate” under the Asset Class filter and click search using our Fund Finder.

 

The takeaway

Given lavish monetary and fiscal stimulus since the pandemic, near-term inflationary pressures emerging from it should not come as a surprise7. Remember that inflation is a key goal for central banks all over the world8 and healthy for the economy, as long as it does not run too much and too fast (hyperinflation).

 

Whether or not inflation proves to be transitory or a sustained shift towards higher rates, positioning your portfolio to weather inflationary pressures can help mitigate shocks to your portfolio and help keep you (level-headed and) on track to your financial goals.

 

Start inflation-proofing your investment portfolio and search for the funds you want with our Fund Finder today or create an account for free if you don’t have one!

 

Want free investment insights to your inbox? Sign up now!

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Sources

1 https://finance.yahoo.com/news/inflation-data-consumer-confidence-what-to-know-this-week-164539544.html

2 https://www.cnbc.com/2021/05/12/consumer-price-index-april-2021.html

3 https://www.fidelity.com/learning-center/trading-investing/money-and-inflation

4 https://www.cnbc.com/2021/05/21/how-to-invest-smartly-when-inflation-picks-up-.html

5 https://www.investopedia.com/articles/investing/081315/9-top-assets-protection-against-inflation.asp

6 https://think.ing.com/articles/commodities-are-buoyant-but-supply-concerns-still-a-worry

7 https://edition.cnn.com/2021/05/26/economy/inflation-larry-summers-biden-fed/index.html  

8 https://www.investopedia.com/articles/03/050703.asp

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