Inflation concerns flared up this past week, with the April consumer price index coming in 4.2% higher than a year ago. While the Federal Reserve says any price spikes should be “transitory,” investors have been flooding to traditional inflation hedges such as gold, commodities, real estate, and Treasury inflation-protected securities, or TIPS. Many funds provide easy access to these assets—though it’s likely that what has worked in the past won’t work as well now. Some ETFs offer different approaches.
The $436 million Horizon Kinetics Inflation Beneficiaries (ticker: INFL), an active fund launched in January, invests in companies that have a lot of hard assets and business models that are less reliant on capital and labor input. “It’s easy to focus on how revenue benefits [from inflation], but we want firms with lower sensitivity to the cost side,” says portfolio manager James Davolos. “That means they don’t need to spend a lot of money to earn a lot of money.”
The fund has heavy exposure to the materials and energy sectors, but also owns many financial-services stocks, particularly exchanges and brokerage firms. Many of its 36 holdings generate revenue from land, royalties, or operating platforms that have been in place for decades. These firms usually have less debt, can easily scale their business, and maintain profit margins even in an inflationary environment, says Davolos. Despite its short history, the fund has gained 17.4% since inception, versus an 8% return for the S&P 500 index over the same span.
Real estate value also tends to hold up well during inflation. The $34 million Nuveen Short-Term REIT ETF (NURE) has an edge by focusing on REITs with short-term lease agreements, which reset rents more frequently and therefore are more likely to rise along with interest rates and inflation. The fund mostly owns apartment buildings, hotels, self-storage facilities, and manufactured homes. Apartment rents have already rebounded more than 3% in the first quarter from a year ago, according to data from Morgan Stanley. The ETF has returned 18.6% year to date, outperforming the Real Estate Select Sector SPDR (XLRE) by four percentage points.
Institutional investors also use options to protect themselves from rising interest rates, but over-the-counter derivatives are not accessible for regular investors. Some ETFs see that as an opportunity. The $3.1 billion Quadratic Interest Rate Volatility and Inflation Hedge ETF (IVOL) has 85% weight in TIPS notes, which offer inflation protection as their face value are adjusted based on the CPI. But TIPS are prone to price declines if inflation expectations cause interest rates to rise—what professionals call “duration risk.”
To counter this, the Quadratic ETF has its remaining 15% in fixed-income options that would profit from rising long-term interest rates or Fed rate cuts. This not only offers a different inflation measurement from the CPI, but also adds a layer of protection when the bonds market sells off, says portfolio manager Nancy Davis. Year to date, with interest rates picking up, the Quadratic ETF has outperformed the iShares TIPS Bond ETF (TIP) by four percentage points.
The Simplify Interest Rate Hedge ETF (PFIX), launched on Tuesday, also aims to have 50% in options that profit from rising long-term interest rates. But it has another 50% in Treasury notes, rather than TIPS. TIPS typically pay much lower yields than comparable Treasury notes. With Treasuries rates near zero, most TIPS now have negative yields. If inflation isn’t enough to compensate for the yield spread—currently about 2.6% for the five-year notes—investors are better off with Treasuries. “I’m not a fan of TIPS; they’re very expensive now,” says Harley Bassman, managing partner of Simplify Asset Management.
Write to Evie Liu at [email protected]
