Vanneman: An Inflation-Protection Primer

June 12, 2014

How To Choose

To review, it turns out that TIP represents good inflation protection coupled with good prospective performance when starting from higher yield levels. Conversely, USCI represents good inflation protection coupled with good prospective performance when starting from lower yield levels.

So, it stands to reason that investors would be best-served by strategically shifting allocations to these two ETFs as well as other ETFs that offer inflation protection from time to time as yields change.

Moreover, there are also other market conditions that we have also found that affect expected performance. What this means is that investors ought to be managing their allocations to inflation-protection assets on an ongoing basis, rather than simply buying a potpourri of asset classes when inflation fears appear.

However, we find that the opposite is usually true. Most investors have an idea of what sort of assets protect against inflation.

Look inside many portfolios and you’ll find a smattering of TIPS, some commodities, maybe SPDR Gold Shares (GLD | A-100) or iShares Silver Trust (SLV | A-99) as well.

But ask the typical investor what’s driving those particular allocations, and how they expect to change the allocations as conditions change, and you’re unlikely to find a systematic approach. We believe there’s good value in simple, low-cost rebalancing rules based on a handful of powerful verities about how various asset classes interact when the inflation environment changes.

Current Environment

Presently, we believe the extremely low real-interest-rate environment argues for a significant weight in commodity indexes in the part of a portfolio designated for inflation protection. Other asset classes appear in that mix as well, but commodities are currently worth the lion’s share of it.

The question, of course, is how the mix should change over time. As interest rates rise, we’ll see TIPS offer better value relative to commodities, and our allocations will shift to that asset class.

And when interest rates rise sufficiently—that is when markets are discounting very high levels of future inflation, as they did in the early 1980s—then “traditional” asset classes such as bonds and equities will actually be priced to offer such generous inflation premiums. At that time, classic inflation-protecting assets will be much less important.

Getting to that point will not be enjoyable, but investors who use ETFs’ liquidity and flexibility to deploy such innovative tactical switching strategies stand a reasonable chance of surviving the journey in good shape.

CLS Investments is an Omaha, Neb.-based third-party investment manager and ETF strategist. CLS began to emphasize ETFs in individual investor portfolios in 2002, and is now one of the largest active money managers using exchange-traded funds, with more than $2 billion invested. Contact CLS’ Chief Investment Strategist Scott Kubie at 402-896-7406 or at [email protected].

Rusty Vanneman joined CLS in September 2012 as chief investment officer. Michael Ashton is managing principal at Enduring Investments LLC, a consulting and investment-management firm offering focused inflation-market expertise. Mike and Rusty shared a cubicle at Thomson Financial’s Technical Data unit in the early 1990s.

ETFs are investment companies aimed at achieving the same return as a particular market index. ETFs will invest in either all of the securities or a representative sample of the securities included in the index. Investing in ETFs involves risk. Please click here for a complete list of relevant disclosures and definitions.


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