10 Years of Hot Inflation? Why Active Hedging Matters

Despite the higher for longer inflationary environment, investors are still hesitating to dedicate part of their portfolios to hedging against inflation. John Davi, CEO and CIO of Astoria Portfolio Advisors, explained the value of an actively managed inflation hedging strategy to portfolios over the next decade. Recorded in October at the Astoria Macro Summit, Davi digs into how inflation hedges are evolving and the quantitative, multi-factor strategy behind the AXS Astoria Inflation Sensitive ETF (PPI) with ETF.com's Dave Nadig. 

Full Transcript

Davi: I've heard all these excuses, Dave, like over the last, you know, four years, AI was going to create this massive deflation. So, I think it just kind of rides hot, and we just kind of get used to this higher for longer. And it's going to be a 10-year higher inflation world, like it was in the '70s.

Inflation Is Here to Stay

Nadig: John, we’re here at your amazing Astoria Macro Summit here. A big part of the thesis I've gotten from you in the last couple months has been the inflation thesis. We've also seen the debasement trade, which is a much more dramatic way of talking about it. Look, we're in this year. We've got gold as the best performing asset, silver is up a bazillion percent. What's driving this, and how do you think this unwinds, and how should investors be positioning?

Davi: You know, we argued about four years ago that inflation would be structurally higher. If you look at the 1980s episode, inflation had these waves, but it settled. It took 10 years for it to settle pre-1970 levels. So the point is we lived for 10 years with elevated inflation. So, inflation is one of these things where it's like once you take it out, the genie comes out of the bottle, it's really hard to stuff it in.

And most people don't want to allocate money and part of the portfolio to inflation fighting strategies. We think that basically most of the core portfolio is in tech, growth, long duration assets, which generally are deflationary. So, why not allocate a portion of your satellite position towards things like gold, energy, REITs, infrastructure? You know, I would even argue crypto.

So, PPI is our solution to kind of allocate across all these different sectors, and could be used as a stand-alone piece to kind of hedge inflation. And the fund's up 32% year to date.

Nadig: So, when people talk about fighting inflation, when I talk to advisors about fighting inflation, you end up with a couple of common answers. One tends to be, “I just buy TIPS”. What's wrong with that as an answer for how to deal with inflation? I mean, tips theoretically are supposed to immunize from these effects.

Davi: Yeah, and you know, Jeffrey Sherman just gave his speech and he argued that TIPS don't really work, and there's a lot of pushback. Which, you know, I don't necessarily disagree with. I just think that there's a new way to sort of fight these inflations, and it is through these sectors like infrastructure, data centers, power plays, nuclear, uranium.

The Evolution of Inflation Hedges

Nadig: So, why do those end up in an inflation portfolio? People talk about inflation protection around things like real assets, whether that's either real estate or whether it's gold or silver. Those are pretty traditional ways of responding to an inflationary impetus. Why are we now talking about data centers?

Davi: I think the idea is that companies that actually – so, companies whose revenues are tied to actual physical assets. And I think that's different, because so much of the S&P as we know now is tech, which is AI, robotics, cloud computing, what have you. It's not a tangible thing, right? But you can go to Virginia and see physical data centers that are going to power the AI trade, right? Or Wisconsin.

Nadig: Got it. So, it's a way of, in some ways, participating in what actually looks more like the momentum trade, the AI trade, the big tech trade, but on the portion of it that is actually real assets-oriented. Is that the way of thinking about it?

Davi: And that's just a portion of our PPI. I wouldn't say it's the majority, but the majority still very much is in industrial stocks – could be Caterpillar, Porsche, like these companies globally, along with your traditional gold. The reason why we like gold so much is that it is a fixed supply asset, right?

There's limited gold in the world. And if you look at the 1970s when we had that big inflation scare, gold went up five times. So, gold may be up only 100% the last 18 months, but, if history is any guide, gold can trend for very long periods of time.

Nadig: And how do you match that against crypto? Because a lot of folks are comparing those two as the same trade. Is buying bitcoin the same as buying gold right now?

Davi: I would say that gold can be mined, it takes a lot longer. So it’s fixed supply but crypto is extremely fixed – at least bitcoin is. There’s only 21 million coins

Nadig: But you include that in your overall thesis?

Davi: We do. We have right now over 9% allocated towards gold and 3% to crypto. And I think that’s sort of the right mix for how we want to design a complete solution to protect portfolios against elevated levels of inflation.

Using a Multi-Factor Strategy to Stay Current

Nadig: Talk to me a little bit about how this changes over time, because this fund’s been around since what, 2021? Something like that. It hasn’t held data centers and energy stocks all the way from the beginning, so you’ve adjusted over time as the markets adjusted. What are you looking at next? What would you also be considering that’s not quite in there yet, and what would it take for you to take something out?

Davi: All good questions. I would say right now there’s a lot of trend and momentum, which we respect that. So as traditional quant guys, we understand factors and what it can do in a portfolio. I would say when things get kind of rich – the whole fund is run through a very dedicated quant process. So it’s multi-factor. We’re looking for, essentially at the end of the day, good growth companies that have high quality, that pay dividends, that are a little bit cheaper than the market, that rank good from a momentum standpoint and actually have sensitivity to CPI.

So there’s 20 different fundamental ratios. At the end of the day, we do oblige by the quant screen, so if the data centers get super, super expensive, it gets kicked out. Because something else, everyone fights with one another in the quant code.

Nadig: So it’s not just blind faith. But does that apply also to the asset that’s much more difficult to put a relative valuation on, like gold? I mean, is there a market which like, “Gold 5, Gold 5k, we’re out!”? How do you know enough is enough? As you pointed out in the ‘70s, from here the run in gold would be the 25,000 or something like that? I can’t imagine you’d be holding to 20,000.

Davi: I think we’d probably – and I’m not the compliance guy – there may be a limit to how much we keep up gold. But now at 9%, we’re not bumping up against any limit. But yeah, so that’s the challenge with gold and bitcoin, is you can do fundamental analysis to say, “Ok, it’s overvalued.” I would say in general, gold is lowly correlated to over very long periods of time, so by that nature we would want to allocate a portion to it.

And since we've been running the fund since 2021, we've always had gold, we just never trimmed it. So, it kind of got, it got very high in the portfolio weight. You don't want to fight trends, is kind of the quant speak. So, we would just let it ride for now.

Keeping a Weather Eye to the (Inflation) Horizon

Nadig: Got it. And then, in terms of things that might be on the horizon that you'd be thinking about including, are there sectors or particular thematic plays where you can see the potential for this to be in the, you know, the 2026 version of PPI?

Davi: Yeah. So, I would say, if inflation starts to be more of a problem outside the U.S. Right now we are very much skewed in the U.S., but obviously inflation is a global problem. We also don't have allocations to emerging markets just because the fund – we never set up local IDs, let's say. But there is in theory, because you have to be active, I think, in PPI, your core could be passive. It could be a rules-based index. But something like we heard Jeffrey Sherman today – mortgage-backed securities, commercial real estate, CMBS.

You got to be active in that, and we think inflation you should be active. But for now, we sort of have our – the fund's performing well, right? It's four stars, it's up 32%. Since we've been running it, it's outperforming the S&P by 20%. It's 0% correlated to the S&P, that’s fairly low, right, in a sort of world where cross-asset correlations are high.

So, I think for now, it's good, but it is systematically quant checked semi-annually. And then if stocks are materially deranked, like if it goes from a one score or two score, if it goes down to five, six, seven, then we have the ability to kick it out.

Nadig: Got it. Last question. So, obviously, your beliefs about inflation are important to whether you make and how much of an allocation you make to an inflation-fighting strategy. You know, we've been sitting here sticky around 3%. You're obviously paying a lot of attention to what's going on here.

What would your baseline prediction be over the next 18 to 24 months for that inflation? Are we saying sticky? Are there deflationary components that could come about from an economic slowdown or an AI productivity boom? Or are there inflationary spikes that we haven't even thought of yet?

Davi: Well, I mean, the Fed's about to embark, they have embarked on a rate-cutting cycle. They cut 100 bips last year. They just cut 25. Chances are they're going to cut again. If anything, that's going to increase inflation more because it'll sort of increase demand and flow if if they're putting money back in the economy.

I've heard all these excuses, Dave, over the last, you know, four years, AI was going to create this massive deflation. I mean, the point is if we're at three to get it to two, which is Fed mandate, they have to kitchen sink the economy, which I don't think is politically something that's going to happen with this administration. So, I think it just kind of rides hot, and we just kind of get used to this elevated, yeah, higher for longer. And it's going to be a 10-year higher inflation world, like it was in the '70s. So.

And that's – it's a big problem because I think inflation impacts certain demographics more. Like if you own financial assets, you own a house, you own stocks, you do sort of well because stocks do generally keep up with inflation. But, you see the lower income, the middle class, they really get hurt, right? So, if people do have 401(k)s, I would say look at your commodity funds, your real asset funds, because I do think that they can help you have a much more efficient ride.

Nadig: Boy, I wish you were wrong about all this stuff, but I fear you're right. John, thanks so much.

Davi: Thank you, Dave.