Judging by the performance of conventional inflation hedges during the past year, the investing public’s worries over inflation are nearly nonexistent. After all, the Federal Reserve’s unprecedented transparency has already led every market participant to believe they will spring into action if and when inflation begins to rise above the 2% threshold.
However, if history has taught us anything, it’s that the market has a way of deceiving the vast majority of the investing public.
So it’s prudent, then, to establish a watch list and periodically review the best options to hedge inflationary pressures. Even if these hazards lay further out in the future than what the market is currently discounting.
There’s no way to know which individual inflation-linked asset or hedges will perform best when the Consumer Price Index or Producer Price Index begins to rise significantly. That’s why some of the best funds to tackle this situation offer so many different things: Treasury inflation-protected securities (TIPS), precious metals, soft commodities, stocks, and real estate investment trusts (REITs).
So, if you want to develop a game plan, consider some of these best funds to fight inflation and protect your portfolio — and your purchasing power — over the long term.
Best Funds to Fight Inflation – Fidelity Strategic Real Return (FSRRX)
Click to Enlarge The Fidelity Strategic Real Return Fund (FSRRX) ranks among our best funds because of its diversified strategy, using a multi-sector approach to targeting assets that should increase in value when inflation is on the rise. Thus, FSRRX is made up of about 27% inflation-protected investments, and about 25% floating-rate notes which track the direction of Libor over time.
Furthermore, 25% of the fund is dedicated to commodity-linked notes and investments whose performance is directly tied to the Dow Jones AIG Commodity Index, which has been shown to positively correlate with CPI.
Lastly, most of the final 20% is dedicated to preferred stocks and common stock issued by REITs, in addition to agency and non-agency mortgage-backed securities.
The asset allocation of the fund is constructed to take advantage of the differing nature of many of these asset classes, which when combined offset each other to form a low-volatility solution for inflation adjusted returns.
FSRRX’s unrealized gains of 5.87% year-to-date are outpacing the S&P 500 Index by a fair margin. The fund carries an expense ratio of 0.77%, or $77 for every $10,000 invested.
Best Funds to Fight Inflation – PIMCO Real Return Asset (PRAIX)
Click to Enlarge The PIMCO Real Return Asset Fund (PRAIX) is a specialized portfolio dedicated to investments in inflation-indexed securities globally. Although its portfolio is currently majority weighted to U.S. inflation-linked assets, it carries small positions in other sovereign issues from countries such as Germany, Australia, New Zealand, Italy and Brazil.
Furthermore, PRAIX has modest holdings in other key areas such as agency and non-agency mortgage-backed securities, floating-rate notes and asset-backed securities.
For individual investors, one of the single largest concerns with owning TIPS securities as a long-term inflation hedge is their high duration and therefore high volatility in relation to changes in interest rates. With the prospect of rising interest rates often labeled as an imminent threat, it’s important to note that the single largest differentiator PRAIX exhibits when compared to an index product such as the iShares TIPS Bond ETF (TIP) is its extensive use of interest-rate swaps and futures to control duration and thereby subdue volatility.
This Morningstar five-star rated fund carries an expense ratio of 0.55%, and is currently up more than 10% so far this year, outpacing both its benchmark and TIP by a considerable margin.
Best Funds to Fight Inflation – Permanent Portfolio Fund (PRPFX)
Click to Enlarge When it comes to fighting inflation, one of the best funds — and one of the longest-standing — dedicated to the cause is the Permanent Portfolio Fund (PRPFX). This fund has been focused on preserving purchasing power since 1982 by investing in a diversified portfolio of non-correlated assets that provide low volatility and international exposure.
PRPFX’s target allocations include 25% in precious metals, 10% Swiss government bonds, 15% aggressive growth stocks, 15% REIT and natural resource stocks, and 35% short-term Treasury and investment-grade bonds. PRPFX charges a net expense ratio of 0.69% and currently controls more than $8.6 billion in total assets.
As its name suggests, PRPFX is designed to be an “all-weather” strategy that exists as a permanent core holding in the context of a diversified portfolio. The majority of the investments in the fund are geared toward traditional inflationary hedges that tend to perform well during periods of rising consumer prices.
Because of the non-correlated nature of the varying investment themes, PRPFX will often go through periods of slow growth. This is particularly true when inflationary expectations are largely contained.
However, that same diversification keeps volatility low and contributes to high profit potential during favorable economic cycles.
Best Funds to Fight Inflation – IQ Real Return ETF (CPI)
CPI is based on a passive investment approach that selects its underlying securities according to a rules-based methodology developed by the ETF sponsor. The goal of CPI is to provide a “real return” above the rate of inflation as measured by the Consumer Price Index.
CPI is structured as a “fund of funds” that purchases other ETFs as its core portfolio holdings. The majority of the current asset allocation is geared toward short-term Treasury bonds with some limited exposure to both domestic and international equities. Thus top holdings include the iShares Short Treasury Bond ETF (SHV), SPDR Barclays 1-3 Month T-Bill ETF (BIL) and the SPDR S&P 500 ETF (SPY).
The end result is a low-volatility portfolio of conservative positions with intraday liquidity and transparency.
Since the fund was released in 2010, the annual returns have been relatively tepid at just more than 1% per year. However, during that time frame, consumer prices have been moderated by sluggish economic growth and aggressive quantitative easing efforts. In a true inflationary environment, this ETF has the ability to shift its underlying holdings to include commodities, real estate, and foreign currencies in addition to stocks and short-term bonds.
CPI certainly could be one of the best funds to have when inflationary pressures take hold once again.
Best Funds to Fight Inflation – iPath Dow Jones-UBS Commodity Index Total Return ETN (DJP)
Click to Enlarge The last weapon in my inflationary arsenal is the iPath Dow Jones-UBS Commodity Index Total Return ETN (DJP). This broad-based commodity exchange-traded note tracks 19 liquid futures contracts that include energy, agriculture, precious metals and livestock.
Rising commodity prices are often times a leading indicator of inflationary activity as these components make up the base materials for finished consumer goods. The performance of commodity prices also can be affected by seasonal consumption and weather patterns that result in a low correlation to traditional stock and bond investments.
While commodity prices have undergone several years of persistent declines, they have rebounded significantly in 2014 which may be a precursor to higher consumer prices. Investing in commodity prices is one way to retain purchasing power when inflationary pressures set in.
DJP is my preferred method of investing directly in commodities because you sidestep any adverse tax consequences of traditional ETF structures. The ETF charges an annual expense ratio of 0.75% and has more than $1.7 billion in total assets under management.
David Fabian is Managing Partner and Chief Operations Officer of FMD Capital Management. To get more investor insights from FMD Capital, visit their blog.