Hi Risers,

We are currently in a period of high inflation across most markets and many investors are facing the problem of how to achieve a level of returns that beats inflation and grows their money. 

What assets provide the best protection against inflation and what investment strategy should long term investors follow in order to grow their portfolio through inflationary periods? As your investment managers, we have answered your questions through this article.

The last time inflation hit these levels in the US and other developed economies were in the 1930s and 1970s. In the early 70s, easy money policies were implemented by the US central monetary authorities in an effort to generate full employment. This resulted in high inflation numbers, with the rate of inflation going from 5.9% in 1970 and hitting 13.3% by the end of the decade. As a result, the US Federal Reserve raised interest rates to nearly 20% to curb inflation, leading to the decline of the stock market by nearly 50%  over a 20-month period. 

Research has also shown that during periods of high inflation and a volatile economic environment, an investor whose first priority is safeguarding their funds while having a pure inflation target should invest mainly in Government Treasury Bills when the investment horizon is short; and should increase their allocation to inflation-linked bonds, equities, commodities and real estate when horizon increases. This is because these asset classes are able to outperform inflation in the long term. 

Meanwhile, in a more stable economic environment with high inflation shocks, the optimal set investment changes for an investor even while still invested in Government Treasury Bills, especially when the investment horizon is short; the investor should increase their investment in equities and nominal bonds commodities when their horizon increases. As various research outcomes confirm the value of alternative asset classes in protecting the portfolio against inflation.    

However, generally, when it comes to the stocks market, our research suggests that reducing the number of stocks bought during inflation may be beneficial to portfolio returns in the short term. Stocks linked to energy and commodities are usually the best bet during such times as they tend to outperform a diversified equity index when the economy is suffering from structural inflation. This means that these equities provide fewer diversification benefits than commodities. Compared to commodities, equities provide a poor inflation hedge but offer better long term returns.

This can be a line of thought for an investor thinking about how best to achieve an objective of return above inflation. But unlike commodities, portions of the equity market, especially those that are more related to energy or materials, provide stronger inflation hedging properties. 

However, Real Estate Investment Trust (REITs) in general, provide a poor inflation hedge, although residential REITs do seem to provide better hedging characteristics than the broad REIT index. 

Also, cash and leveraged loans provide reasonable inflation hedging characteristics, despite the fact that the former does not provide sufficient return for most long term investors. Non-US currencies provide diversification and potentially better returns than cash. Commodities are a non-homogenous asset class and sub-sectors such as energy and industrial metals provide good inflation betas. Implementation of a commodity’s position within a portfolio is key to ensuring that this does not result in a drag on the portfolio due to their lack of cash-generating properties.

Finally, the best investment strategy all depends on your time horizon; and because Rise believes in building or creating wealth over a period of time, we have provided asset classes that perform well for investors with both short and long term horizons. 

Showing below are the various asset classes and how they performed during periods of inflation and periods of low inflation.