Inflation Protection: A Missing Component in Most Portfolios

From monetary policy to the green energy transition, VanEck sees several factors that are setting the stage for a prolonged higher inflationary environment. In an interview with IN Create, David Schassler, portfolio manager of the firm’s Inflation Allocation ETF (RAAX), explained his view on inflation, and what investors should do to protect against it.

IN Create: Why should investors be more worried about inflation today?

David Schassler: Some of the items causing a recent spike in the Consumer Price Index (CPI) – supply constraints and microchip shortages, for example – are transitory. But we believe there are several factors that could be with us longer term. The first is the spike in the money supply, which has increased by roughly 25% since March of 2020. Unlike after the financial crisis, when money printing was used to shore up banks, this time the excess money supply is reaching consumers, and just as important, the consumers who most need it.

When money printing finds its way to consumers who need it, they tend to spend it, and the ensuing demand pushes up prices. We saw something similar after Lyndon B. Johnson’s “war on poverty,” which played a part in driving inflation in the 1970s.

An additional factor that could drive long-run inflation is the pickup in home prices. Shelter is the largest component of CPI, though it is measured largely through rent prices and rent equivalent yield. While home prices have risen, we haven’t seen rent prices catch up. That will be next. The green energy transition represent a structural development and another driver of longer term inflationary pressure.

IN Create: That’s interesting. Explain how the green energy transition could play a role in driving inflation.

David Schassler: It’s two-fold. With the world moving away from oil, companies are reluctant to invest in new development projects. That will ease supply but oil consumption won’t level off immediately, creating supply-demand imbalances that cause upward price pressure. Meanwhile, the green energy transition will heighten demand for metals such as copper, nickel, cobalt and lithium, which are essential to the production of electric vehicles, and wind and solar technologies. For perspective on how big the growth is, the International Renewable Energy Agency estimates the resource transition could total $110 trillion over the next 30 years. These commodities are hard to mine and produce, so it will take considerable time for supply to catch up to demand.

IN Create: What’s misunderstood, or perhaps underappreciated, about inflationary periods?

David Schassler: I think investors are unaware of how little inflation protection the average portfolio offers today. A few statistics make this clear. If you look at the S&P 500, back in 2008 real asset industries made up 21% of the index. These are generally the industries or stocks that offer inflation protection. Today, due to the outperformance of growth stocks relative to the broad equity market over the past decade, they comprise only 8% of the index. Meanwhile, if you look across all Morningstar funds and categories, only 0.74% of all assets are invested in commodities, natural resources and precious metals (based on net assets as of May 31, 2021). To me, that shows investors are not currently dedicating a portion of their portfolio to inflation protection.

IN Create: From an allocation perspective, what should advisers do to prepare for potential inflation?

David Schassler: To fully offset inflation risk concerns, we can see a 10% - 15% allocation to inflation protection assets. We’re a proponent of owning a diversified set of real assets, because they perform differently at different points in the inflationary cycle. As an example, our Inflation Allocation ETF invests across three categories of real assets:  financial assets, which includes gold, gold equities, and bitcoin exposure; resource assets, capturing commodities and natural resource equities; and lastly, income assets, such as infrastructure, REITs and MLPs. Our quantitative process seeks to overweight the assets that are in favor while always staying well diversified. Currently, we have around 50% of the portfolio invested in commodities and natural resource equities which are leading the markets higher

IN Create: Is there a case for holding some of these asset classes if we don’t experience excessive inflation?

David Schassler: Inflation is a risk whether it is at 2% or 10%. Some real assets, such as commodities, natural resource equities and gold, have historically responded well in periods of high inflation. Other real assets, such as REITs, infrastructure and MLPs, have the potential to perform very well in low and moderate inflationary regimes because of their attractive yields. RAAX adapts to the different regimes and makes these allocations decisions for investors.

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