Investors can consider a real asset exchange traded fund strategy to protect their portfolios amid times of entrenched inflation.
In the recent webcast, How to Stay One Step Ahead of Inflation with Real Assets, David Schassler, Portfolio Manager and Head of Quantitative Investment Solutions Group, VanEck, warns that inflation is here and things could still get worse before turning toward the better. He explained that massive and coordinated monetary and fiscal policies lead to booming demand that pressured supply chains. Meanwhile, the inflation psychology is setting in and risks inflation becoming entrenched. Additionally, the Federal Reserve is not well positioned to tackle inflationary pressures.
Consequently, Schassler argues that investors will have to ready their portfolios to deal with a more entrenched inflationary environment or adjust allocations to reflect this new normal. Specifically, he believed that investors need to reassess portfolio allocation to account for longer-term impact. Current allocations to traditional assets reflect a pro-growth, low-interest rate environment. Real assets have historically acted as an inflation hedge, including those that provide competitive, alternative yield.
Highlighting the ongoing inflationary pressures that could remain, Schassler notes that the largest component of CPI is Shelter, which looks at rent and equivalents, and rent prices typically lag home sale prices by 12 to 18 months, so the cost of Shelter could continue to rise as rents catch up to the recent spike in home prices.
The overall inflation outlook remains elevated after the dramatic increases in the money supply contributed to supply and demand imbalances. Schassler points out that U.S. Personal Savings and total Household Net Worth have exploded to the upside, and the delayed impact of the stimulus is expected to have a sustained impact on demand.
Schassler believes that the COVID-19 pandemic dramatically altered consumption patterns. Spending is booming for both goods and services. Service demand is also expected to increase as pandemic risks subside.
The ongoing global supply chain hurdles remain and will continue to impede the efficient distribution of goods, which will contribute to higher costs.
Furthermore, near-record job openings have contributed to higher wages and broad inflationary pressures. Schassler notes that the correlation between wages and inflation spikes significantly during periods of high inflation. Looking ahead, the continued upward pressure on wages is expected to contribute to higher inflation.
Rising commodity prices due to supply chain issues have been a recent contributor to the heightened inflationary outlook. Specifically, the Russia-Ukraine war and Western sanctions have upended normal commodity supplies out of the region. Russia is a top 3 global supplier of energy, base metals, precious metals, bulk metals, fertilizers, and soft commodities. Supply and demand imbalances were significant before the invasion and this was evident in pricing shocks. Schassler warns that disruptions are expected to add significantly to the inflation pressures globally.
War has historically coincided with higher inflation. Consequently, Russia’s significance as a commodity producer, combined with pre-existing supply and demand imbalances, make this conflict particularly inflationary.
Meanwhile, Schassler cautions that the Fed is not well positioned to fight inflation. He highlighted the high debt-to-GDP ratio that creates a difficult environment to significantly raise interest rates. In addition, the last attempt to “normalize” interest rates was from 2015 to 2018 and the Fed was only able to reach 2.5% before the markets revolted. The unemployment rate in the U.S. also jumped to 10.7% in 1982 after the Fed dramatically increased interest rates to fight inflation.
As a way for investors to deal with it, Schassler notes that commodities and gold have historically outperformed during periods of high inflation. Broad real asset prices have historically outperformed during periods of high inflation as well.
Schassler also argues that it is not too late to focus on real assets, even after the recent spike since raw materials have been underperforming over the past decade and are only recently just beginning to catch up. Over the past 10-years, the S&P 500 Index has outperformed the Bloomberg Commodity Index by more than 230% and the S&P Global Natural Resources Equity Index by more than 160%.
The VanEck Inflation Allocation ETF (RAAX), an actively managed fund of funds that seeks to maximize long-term real returns, can help investors gain exposure to real assets. The fund invests in exchange traded products with exposure to real assets, such as real estate, commodities, natural resources, or infrastructure, and may hold up to 100% cash or equivalents.
Schassler explains that real assets include commodities, natural resource equities, gold, bitcoin, MLPs, REITs, and Infrastructure. An allocation to real assets can play three key roles in a portfolio, such as a hedge to inflationary pressure, a leverage to global growth, and a portfolio diversifier.
RAAX also dynamically adjusts exposures based on quantitative factors to perform in high and low inflationary regimes. The ETF’s portfolio diversification standards are designed to provide a consistent risk profile over time.
Schassler also highlights some other pure play themes that could benefit from heightened inflationary pressures. For instance, the VanEck Vectors Agribusiness ETF (MOO) captures the play on global population growth and supply concerns, which are driving increasing food demand and the need for efficient agricultural solutions. Additionally, the VanEck Vectors Oil Services ETF (NYSEArca: OIH) tracks the performance of U.S.-listed companies involved in oil services to the upstream oil sector, which include oil equipment, oil services, or oil drilling.
Financial advisors who are interested in learning more about real assets can watch the webcast here on demand.