Over the past year, inflation has hit American budgets and portfolios hard. In the 12 months to August, the average cost of the consumer goods basket he rose 8.3%, with certain categories such as food and gasoline rising even faster, according to the Bureau of Labor Statistics.
Investors had nowhere to hide as the Federal Reserve launched a series of rate hikes to curb inflation. Bond prices, which move in the opposite direction of interest rates, fell 12% in the year to August. Investors also fear the Fed’s actions could plunge the economy into recession, with the stock market dropping nearly 16% over the same period.
Ford O’Neill, co-portfolio manager of the Fidelity Strategic Real Return Fund, a mutual fund strategy focused on protecting investors from inflation risk, said even if money was kept in cash. , I can’t say it’s going well. “Even if you feel safe in your money market account and its value hasn’t changed, I can assure you that the returns are well below that of inflation you’ve experienced,” he says. actually has a negative real return.”
O’Neill-backed funds aim to provide returns that outpace inflation over a period of three to five years. Given today’s high inflation, it’s no coincidence that his annual return of 2.7% through August outpaced his negative double-digit returns in stocks and bonds.
The details of this fund can reveal how professional investors approach the fight against inflation and how they should think about risk management in their own portfolio strategies. Contents is like this.
The assets of this fund are designed to protect investors from inflation
To find which assets work best in funds that aim to outperform inflation, O’Neill and his co-managers look at the long-term, 12-month rolling returns of various investments. See how often it tends to outperform the Consumer Price Index.
The following four asset classes hold significant positions in the fund and have an above-average track record against inflation. Percentages next to each show how often assets outperformed inflation from December 1973 to June 2022, based on rolling returns, according to Fidelity data.
- Floating rate debt (80%): Also known as a “bank loan,” it is a loan (usually of low quality) made by a bank to a business. The interest rate on this liability is typically tied to a short-term benchmark that resets every 30 to 90 days. This means that these bonds tend to hold their value even when interest rates are rising. In other words, these bonds tend to benefit when central banks raise interest rates to cool an inflationary economy.
- Tips (75%): As the name suggests, Treasury Inflation Protection Securities are designed to protect bond investors from rising prices. Like the Treasury, these bonds are issued and backed by the U.S. government, but with extra problems. The bond’s principal value is adjusted for inflation. TIPS pricing revolves around the “break-even rate”, the difference between the TIPS yield and the yield on a similarly dated US Treasury. The 5-year rate is currently at 2.33%, suggesting that 5-year TIPS will outperform 5-year Treasuries if inflation averages above 2.33% over the next five years.
- Real estate stocks (70%): “When you think about what makes up CPI, housing is the biggest part,” O’Neil points out. Real estate investment trusts (stocks in companies that own or operate income-generating real estate properties) enjoy pricing power, so they tend to keep up with inflation. Companies that offer long-term leases usually factor inflation adjustments into their contracts, allowing short-term landlords to raise their rents as home prices rise.
- Commodities (59%): If you look at the list of categories listed in the Consumer Price Index, O’Neill points out, you’ll find commodities everywhere. “Commodities are baked into his CPI,” he says. “Think of utilities, gasoline and kerosene. Airfare prices are based on jet fuel prices.”
The track record of beating inflation is mixed among the assets held by the fund, and that’s sort of the point. By building a portfolio of investments that don’t move at a constant pace, managers are spreading their bets knowing that their performance will rise and fall under varying market conditions.
“What commodities went through in the wake of the global financial crisis has more than made up for it over the last three years,” says O’Neil. “Property has rebounded from March 2020 lows, but on a one-year basis, property is currently underperforming.”
In the long run, this well-diversified approach proves better than the sum of its parts.From December 1973 to June 2022, an asset mix similar to Strategic Real Return outpaced inflation 80% of the time.
When it comes to mitigating inflation, as is the case with any kind of investment risk, it is better to invest in a broad range of investments than to choose one that seems like a silver bullet. says O’Neill.
“You never know exactly when things will work out. You have to give yourself multiple chances to win.”
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