Mixed Record Of Inflation Hedges

October 06, 2014

Data Limitations

We do have a bit of a data problem. The lack of sustained, high inflation in the developed markets since the mid-1980s has been good news for consumers. But it’s bad for this article—bad because there has been an explosion of investable inflation-hedging instruments over the past 20 years, but no real good bouts of inflation by which we can judge them.

Where is this constraint binding? Unfortunately, in many of the most interesting assets. Neither oil nor gold prices were market based in 1970—the beginning of the most recent major inflationary period. The REIT index—the best way to think about real estate as a hedge—only goes back to 1972. U.S. inflation-indexed bonds only began trading in the 1990s.

This problem is even more severe when we consider our particular corner of the investment universe: ETFs. These are still in a phase of exuberant growth in the breadth of instruments on offer. So we’ll use a mixture of common sense and research of analogous instruments in the past to determine which ETFs to add to a portfolio.

What We Want In Inflation Hedges

What do we mean when we talk about protecting from inflation? One thing you could do is just look at asset returns adjusted for inflation over the long run. What you’ll find is that whatever does the best in nominal—that is, unadjusted for inflation—terms will also do the best in real terms adjusted for inflation.

As is well known, during most long periods in the United States, stocks perform better than other asset classes. So, in an uninteresting sense and over a long enough period, stocks could be your inflation hedge.

We can see this in the following two charts. The first one covers a long period of fewer assets: 1954-2014, incorporating all of the inflationary 1970s. The second one covers a shorter period of more assets: 1978-2014. They both show that whatever asset has returned the most over the period in nominal terms will usually return the most in real terms as well.

US_Asset_Class_Returns_1954-2014

US_Asset_Class_Returns__1978_2014

 

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