Long gone are the days in which a traditional 60/40 portfolio will provide clients with the diversification and income desired.
According to Christopher Huemmer, senior investment strategist for FlexShares’ ETFs, many advisors are currently overlooking the need for real assets or alternative assets in a portfolio, two asset classes that play a particularly important role in an inflationary environment.
“You really can’t today look at equities, fixed income, or even cash,” Huemmer said. “On a real yield basis, having that real asset exposure is really key.”
Looking at correlations between different asset classes — in both inflationary and deflationary environments — is critical in ensuring that an investor’s portfolio is resilient in all market conditions.
“Since the mid 90s, we’ve been in pretty much a deflationary environment,” Huemmer said. “What you see is stock and bond correlations or stock and bond price correlations are negatively correlated in deflationary environments.”
Stock-bond correlation tends to be lowest when inflation and growth are low — deflationary recession — and when equities are weak and volatile, provoking investors to run for quality and value.
“What you see in an inflationary period, stock and bond prices are positively correlated, and that’s because it’s not not growth that is driving interest rate hikes, it is inflation,” Huemmer said.
What we’re seeing today, according to Huemmer, is that when inflation drives the interest rate hikes, stock prices will react negatively to rate hikes.
In a situation like this, “the traditional 60/40 portfolio, where you get that diversification between equity and bond, tends to fall out of the box, and you need to look elsewhere, whether that’s to alternatives, or to real assets,” Huemmer said. “Real assets is a great way to augment that 60/40 portfolio and help yourself in inflationary periods.”
Investors seeking enhanced diversification and potential inflation protection through a real assets strategy should look to the FlexShares Morningstar Global Upstream Natural Resources Index Fund (GUNR), the FlexShares Global Quality Real Estate Index Fund (GQRE), and the FlexShares Real Assets Allocation Index Fund (ASET).
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