Supply Chain Restructuring Could Cause Inflation; IVOL Hedges

The increased pressure the war in Ukraine has put on an already-strained global supply chain could have countries doubling down on domestic growth and companies stepping back from global supply chain reliance. That’s according to Larry Fink, CEO of BlackRock, in an annual letter to shareholders, as reported in Financial Times.

The pandemic’s impacts on supply chains have been numerous, from shutdowns causing multi-month backlogs at major ports, to shortages in materials, to increasing consumer demand broadly far outstripping supply. Now the pullback from Russia by Western countries and the impacts that the war has had on commodities and energy have caused further pressures for companies and countries globally.

“The Russian invasion of Ukraine has put an end to the globalization we have experienced over the last three decades,” Fink wrote, adding, “companies and governments will also be looking more broadly at their dependencies on other nations. This may lead companies to onshore or nearshore more of their operations, resulting in a faster pull back from some countries.”

As companies look to ramp up their production of hard-to-obtain materials within their own countries, it could cause an entire restructuring of global trade.

“A large-scale reorientation of supply chains will inherently be inflationary,” Fink wrote.

This is one more potential inflationary pressure to pile into an already-overflowing basket of inflation drivers as markets continue to experience volatility while the war rages on and inflation persists within the U.S.

Hedging Against Volatility in Fixed Income and Increasing Inflation

The Quadratic Interest Rate Volatility and Inflation Hedge ETF (IVOL) from KFAFunds, a KraneShares company, is designed to have a twofold hedge against an increase in fixed income volatility and/or an increase in inflation. The fund also seeks to maximize yield curve increases, either brought about by long-term interest rates increasing or short-term interest rates falling; both are tied to big equity market declines.

IVOL is the first of its kind in active and passive options and offers access to the OTC fixed income options market, the mechanism it uses for long interest rate volatility. The fund invests in a mix of U.S. Treasury Inflation-Protected Securities (TIPS) of any maturity, which are U.S. government bonds whose principal amounts increase with inflation.

It also invests in long options directly tied to the shape of the U.S. interest rate swap curve, which steepens when the spread between longer-term debt instrument swap rates and shorter-term debt instruments grows larger, flattens when the spread grows smaller, and inverts when the spread is negative.

IVOL is actively managed by Quadratic Capital Management, an alternative asset management firm with experience in the options and volatility markets. It expects to invest less than 20% of the fund in option premiums and seeks to purchase options with a time-to-expiration between six months and two years.

IVOL carries an expense ratio of 1.05% and has approximately $1.8 billion in assets under management.

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