Dave Nadig posted a question on Twitter asking if you had a client who was very concerned about inflation, regardless of whether they were correct, what would you recommend? Then he mentioned a few symbols. The following chart is tough to look at but it includes most of the symbols he mentioned along with a few others that I am aware set to 2022 when inflation spiked pretty hard.
Some of them did ok in the context of going up a little or not going down anywhere near as much as the broad market or 60/40 proxies like Vanguard Balanced Index (VBAIX). I did not include short term TIPS funds but those weren't great, down high single digits. Not great but much better than the AGG for whatever that is worth.
Long dated TIPS funds got hit very hard. They may have inflation protection but they also assume interest rate risk. I used to own TIP but then figured out the interest rate problem back in what I am guessing was about 2013. The Quadratic Interest Rate Volatility And Inflation Hedge ETF (IVOL) is a tough one to figure out...as in I can't figure it out. Yahoo had it down 17.01% in 2022 (add back about 4% in distributions). The fact sheet talks about protecting against the sort of things that happened in 2022 but it was down a lot. Maybe I have it wrong but this seems like another example of a fund not meeting the expectation it sets.
IWIN from Amplify looks like it owns the right things including commodities, mining stocks, yet it was down 20%. RAAX, INFL and PPI all finished 2022 very close to unchanged which is a win in a down 17% (for VBAIX) world. Client holding PAVE was down 5% or so and I lucked out with client holding XME being up 10%.
That leaves us with ProShares Inflation Expectations ETF (RINF). I've known about this fund but didn't realize it has been around so long, back to 2013 despite only having $20 million in it. In 2022 it was up 3.70% per Yahoo. It was actually more than that, it paid a little over 1% in dividends that year. Yahoo shows the yield currently to be 5%.
Back to Dave's question about a client being concerned about inflation. I think 2022 showed that for the most part, the market dynamics that year of stocks and bonds falling a lot was a bigger driver for most "inflation" funds than actual inflation. More succinctly, inflation products couldn't overcome a serious drawdown.
Commodities are supposed to be inflation hedges and in some cases yes for 2022 but some cases no as IWIN showed us. Managed futures is sort of commodities and of course had a very good year in 2022. Maybe more important that owning a fund with the word inflation in the name, is owning one or more funds that are reliably negatively correlated to equities or maybe a low correlation is good enough.
That's just a sampling of the funds from the chart above and I highlighted their respective correlations to the S&P 500. If you're worried that stocks might go down because of inflation then protection with a low to negative correlation is going to be better than something with a high correlation or at least I would have that expectation. PPI and INFL did pretty well to be flat but their respective correlations are kind of high. TIP was down a lot and its correlation is surprisingly high and RINF is quite low and it did pretty well.
The very simplistic primer of what RINF does is it goes long 30 year TIPS and short long dated bonds. When inflation was nowhere to be found, RINF went down and in the last few years as inflation came back, RINF has been going up.
The above backtest is consistent with other tests we've run. RINF sort of allows for leveraging down to increase the equity allocation but you can see in the first 2/3 of the back test the RINF blend lagged when inflation expectations were nonexistent. There were a few very good years for the RINF portfolio, no relative stinkers but it did lag a few times but in 2022 it was down 10%, much better than VBAIX but not as good as the managed futures blend.
Putting it all together with a 5% weighting to RINF we see the CAGR is much higher than VBAIX with just a modest boost in standard deviation. I think those numbers make for a good tradeoff especially since Portfolio 1 was down less than half VBAIX' 2022 decline. Maybe not during crashes like 2022 but plain vanilla equities tend to more than offset inflation over longer period so probably no need to dump equities if you're expecting higher inflation.
I am satisfied that RINF adequately implements the inflation breakeven trade. It is harder to say how often we might need that exposure going forward but I think it can keep helping when inflation expectations are high and be a drag when inflation expectations are low which is in line with what the fund should do. If there is any value to adding RINF (I'm not there at this point) I think it would be in small doses. I think there would be diminishing returns from going too large.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
2 comments:
What about Simplify's PFIX? OTC options on interest rate. Might need a significant portion (10%?) to hedge such violent increases in rate but seems like it's done well since 2022.
I know PFIX has it's fans and it had a couple of phenomenal runs. I haven't looked closely at, the payout for 2023 may have been the largest one I've ever seen.
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