Equities, in general, have been among the best long-term hedges against inflation. Finally, we add exposure to the infrastructure space via the SPDR Global Infrastructure ETF (GII | C-70). The infrastructure space can generally be characterized as consisting of firms with strong, stable cash flows and high pricing power.
In the commodities space, we divide our exposures between physical commodities—gold and silver—and companies engaged in the commodity space; namely, agribusiness and energy. For gold and silver exposure, we look to the precious metals ETFs, the SPDR Gold Shares (GLD | A-100) and the iShares Silver Trust (SLV | A-99). Both offer inexpensive, liquid exposure to physical commodities.
Paired with that is exposure to companies in the agribusiness and energy space by way of the Market Vectors Agribusiness ETF (MOO | C-91) and the Energy Select Sector SPDR Fund (XLE | A-98). Natural supply constraints in both sectors tend to drive prices higher during periods of increased demand.
Despite the pernicious effects of inflation on fixed-income holdings, our Real Return Strategy maintains a 25 percent allocation to the bond market. The exposures, however, include inflation-linked bonds such as those found in Treasury Inflation-Protected Securities (TIPS).
Nottingham uses both the iShares 0-5 Year TIPS Bond ETF (STIP | A-99) as well as the iShares TIPS Bond ETF (TIP | A-99) to hedge against domestic inflation, while holding the SPDR DB International Government Inflation-Protected Bond ETF (WIP | C), to guard against broader global inflation, mainly in the eurozone.
Short-term adjustable rate bonds are also held via the iShares Floating Rate Bond ETF (FLOT | 77), the PowerShares Senior Loan ETF (BKLN | C) and the SPDR Blackstone / GSO Senior Loan ETF (SRLN | C). All of the above should outperform traditional fixed-rate bonds in an inflationary environment.
The final asset class is loosely defined as “alternatives.” In this category, we include exposures to real estate investment trusts as well as the currencies of commodity-based economies, such as those of Australia and Canada. We currently have exposure to the Vanguard REIT ETF (VNQ | A-89) and the Vanguard Global ex-US Real Estate ETF (VNQI | B-81). Although REITs tend to trade in sympathy with more traditional fixed-rate securities, the ability of property owners to raise rents over time helps make the REIT sector a decent long-term hedge against inflation.
For currency exposures, we use the CurrencyShares Australian Dollar ETF (FXA | B-100) and the CurrencyShares Canadian Dollar ETF (FXC | B-98). Both have annual expense ratios of 0.40 percent per year, or $40 for each $10,000 invested, and have enough liquidity to accommodate sizable positions.
Better To Be Early And Prepared ...
With the latest CPI for February showing no change in prices over the preceding 12 months, it would be hard to blame investors for ignoring inflation.
Having invested through multiple periods of rising interest rates throughout our history, however, we think it’s crucial to have some inflation-hedging strategy to consider. With the size of the Fed’s balance sheet having quintupled over the past six years, and with the odds for a late 2015 “lift-off” rising, now might prove to be a shrewd time to consider protecting fixed-income investments.
Exchange-traded funds can offer investors numerous ways to guard against rising prices. As always, it’s important to select low-cost, transparent and liquid ETFs when putting a portfolio together. A diversified mix of liquid, low-cost, transparent ETFs, thoughtfully constructed and periodically rebalanced, should help investors guard against the deleterious effects of inflation when it finally arrives.
Again, in our opinion, it’s better to be early and prepared than late and regretful.
At the time this article was written, the author’s firm owned shares in client portfolios of all the ETFs mentioned.
Nottingham Advisors is an ETF strategist that manages and advises on more than $1 billion in assets for advisors, institutions and individuals. Nottingham has been using ETFs since 2001 and currently offers five unique strategies with focuses on risk-based total return, current income and real return. To learn more, visit www.nottinghamadvisors.com or contact Nottingham directly at 716-633-3800. For all relevant disclosures, please go here.