The inflation rate has tumbled in 11 months. Still, the consensus is growing that prices will keep rising above the Federal Reserve’s 2% target for reasons more resistant to easing supply chain pressures and rising rates. So what does that mean for forward-looking inflation investment strategies?
VettaFi contributor Dan Mika spoke with Greg Bassuk, CEO of AXS Investments, about how the changing nature of inflation alters the strategy around its actively managed AXS Astoria Inflation Sensitive ETF (PPI).
Dan Mika, VettaFi: Inflation has slowed down from the 8%-9% peaks we saw last year to 4%, but that’s not a comfortable place for the Fed. Meanwhile, surveys show that people expect inflation to remain above the 2% target for a few more years. How does this slowdown change your and the firm’s views on inflation? And how has that changed the approach to running PPI?
Greg Bassuk, AXS Investments: Concerning our view as a firm on inflation, we have thought that prices would remain elevated for quite some time. We’ve definitely made some progress with inflation generally coming down. However, the progress people are seeing now has been slower than expected. With respect to our outlook, the recent developments are not too surprising.
With respect to our PPI ETF, we launched it as the first ETF to include both inflation protection exposures. So, TIPS and commodities, for example, have been used historically as effective inflation hedges. We also include exposures that historically have done well in high-price environments, like cyclical stocks. That combination of exposures for PPI can be an effective solution for investors. Not only when inflation rises but also when prices continue to remain elevated.
We are seeing that now. It is what we’re seeing as greater consensus among economists and market observers regarding the outlook for the balance of 2023. Both at the firm level and at the fund level, our view has remained consistent. But with PPI being both a hedge for inflation and an opportunity for investors to potentially profit from high-price environments, we expect it to have legs longer than those of competitor funds.
A Shifting Inflation Narrative
VettaFi: The inflation narrative has shifted from supply chain pressure caused by pandemic-related shortages to consumers continuing to spend and engage in a very tight labor market despite months of recession signals and Fed hikes. How does that change the specific asset classes AXS looks at when aiming to outperform in this lower-inflation scenario?
Bassuk: We’ve seen gas and grocery prices, for example, come down. But [prices] we’re seeing in some other areas continue to have greater resiliency. In fact, we’re seeing significant price climbs. Those areas include things like dental care, car insurance, and education expenses. With all that, when we see those kinds of developments, we can rotate within our PPI ETF among different exposures and asset classes.
Cyclical stocks, in particular, are a great example where historically, they’ve done well in high-price environments. We’re seeing some of the trends you referenced and elevated prices in durable goods and leisure and luxury. These are areas where PPI can allocate and adjust to having greater exposure in those areas as inflation comes down. Put another way, within the same ticker, PPI is a one-stop investing in a sense. We can take care of the rotation to minimize the inflation-hedging elements and overweight some other areas. This includes autos and consumer durables, airlines, and other asset classes that tend to do well in these cyclically favored environments.
Role of the Inflation Trade
VettaFi: The S&P is in a bull market right now, tech stocks are on fire, and investors can yield a little bit more than 4% if they just buy an aggregate bond ETF like the iShares Core U.S. Aggregate Bond ETF (AGG) or the Vanguard Total Bond Market ETF (BND). What role does the inflation trade play in this current market environment where it seems like everything has shaken off a really tough 2022?
Bassuk: We’re seeing a few things with the turnaround where the equity markets and tech are now in favor. That was not so much the case not too long ago. We see it slightly differently. We see it as the most recent wave in a highly volatile and uncertain market environment. Even with inflation, we’re still seeing mixed results come in. There’s a lot of uncertainty around the direction of inflation and core inflation. In the broader economic indicators, we’re still seeing mixed results.
It is true that, right now, the S&P 500 and, broadly, the equity markets are on a good run. But the multi-asset exposure in a fund like PPI, we think, is much more resilient than investing in, let’s say, just commodities and TIPS, or what people historically would think of as the inflation trade. There was a disproportionately high focus on “what I can invest in to hedge inflation?”
PPI is a multi-asset product that gives greater diversification in this time of uncertainty and volatility. Even with technology being quite strong, looking back over a longer period, you see the ups and downs. PPI is a long-term strategic holding. Even when the equity markets are back in favor as they are now and inflation seems like it’s generally coming under control, there’s reallocation within the portfolio, either to cyclical stocks or to greater diversification among asset classes. It allows our inflation trade to enable investors to potentially profit on both the upside and the downside.
One more quick point: we’re also seeing [growth stocks perform]right now, but we believe that as we get further into 2023, we’re also bullish on a value rotation. It’s another area where exposure to a fund like PPI can position investors on that side of the trade. That returns to the ability to rebalance and adjust among asset classes. It allows the potential to profit on the growth and value sides if that should turn around…
What Lies Ahead
VettaFi: You mentioned PPI is a longer-term strategy. The last five-year breakeven inflation rate is pricing inflation at around 2.15%. How long do you expect this inflation story to drop from the last two years of highs but settling in above that 2% inflation target?
Bassuk: Economists anticipate the inflation measures, the consumer and producer price indexes, are coming down more in line with the Fed’s longer-term goals. We’ve designed the PPI ETF so that as inflation comes down, the ETF will tend to rotate out of the inflation hedges and more into the other asset classes. That’s why we named the ETF “inflation sensitive.” We didn’t name it – as many funds are named – the “inflation protection” or “inflation beneficiary” ETF.
This ETF is designed to move dynamically as inflation goes up and down and rotate in and out of certain asset classes and exposures within the fund. The PPI ETF out of 418 funds in [Morningstar’s Global Allocation category] for 2022 and was the number one performer in its Morningstar category and fifth-top performer in the past month. I mention that because it goes to the heart of your question: when inflation was rising, rising, rising, and the fed rate was therefore rising, rising, the inflation-sensitive nature of the portfolio really outperformed.
Looking back over the last 30 to 60 days is the point at which economists and even the Fed – as reflected by their decision to pause rate hikes – is highly relevant for our ETF. It’s a period when there’s greater recognition that inflation is coming more in control. PPI continues to outperform because it’s now rotated out of the inflation hedges, which performed well, and into the asset classes that tend to do well while prices remain elevated. In our case, [that means]mostly into an overweight in cyclical stocks.
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