“CPI is incorporated into portfolios specifically to provide a real return over inflation, without relying purely on duration,” said Bruno. “Therefore, inflation is the primary driver of return and risk for the strategy. We see more conservative portions of the portfolio go to CPI compared to corporate bond or floating rate positions. We see cash being incorporated more into portfolios not for liquidity needs, but because investors do not find a suitable strategy that provides a real return over inflation without a significant reliance on duration.”
The prevailing sentiment in the markets is that the Federal Reserve is set to increase interest rates for the rest of 2018, particularly when the S&P 500 is in the midst of the longest bull market ever. However, at some point, the jubilation in the record highs becomes overwrought exuberance and the markets will experience a correction or downturn–a scenario primed for investors to use CPI.
“If the market downturn happens in bonds, where there is an overreaction to rising rates, CPI would likely better provide a real return over inflation, as it is designed to do”, said Bruno. “Equity market downturns tend to result in a risk-off flee to duration-based products such as corporate bonds, so if we are talking a typical equity sell-off; corporate bonds may fare well. We find that setting expectations is important with alternative strategies, because most tend to ask only about traditional risks like bond and equity sell-offs, when the question should be more around the intention of the position in a portfolio. For a real return over inflation that does not rely mostly on interest rate sensitivity (duration), CPI makes a lot of sense.”
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