Hedge Against Inflation With ETFs

Another frustrating aspect of inflation is the difficulty many investors face in protecting their portfolios from the phenomenon. Debates over the relative merits of various securities as safeguards against inflation have raged for decades, with different investors pursuing different strategies. Each inflationary environment is unique, and inflation does not exist in a vacuum; there’s no silver bullet that is guaranteed to offset it. But there are dozens of ETFs that may be useful for those worried about the impact of rising prices on their portfolios.

Below, we profile 25 ETFs that may have appeal as tools to fortify portfolios against inflation.

Unlike most of the ETFs on this list, CPI doesn’t offer exposure to just a single asset class; it uses a more complex strategy to combine various types of securities in a manner that will result in protection against the potentially adverse impact of inflation.

This ETF is structured as a fund of funds, investing in a number of various ETFs with the objective of providing a hedge against inflation. It is meant to deliver a real return above the rate of inflation as represented by the Consumer Price Index. To do this, CPI has a core holding in short-term bonds complemented by positions in other asset classes, potentially including gold and other commodities, emerging market stocks, and currencies. The component ETFs are selected based on a proprietary methodology, and can shift regularly based on movements in measures of inflation and other observable price signals.

WisdomTree’s RRF is designed to deliver a comprehensive approach to combating inflation. The majority of the RRF portfolio consists of inflation-protected bonds, but this product goes beyond U.S. borders to include debt from issuers in developed and emerging international markets as well. To complement the position in inflation-linked bonds, RRF also includes commodities; that segment of the portfolio includes both long/short, traditional long, and gold exposure.

Fixed-rate debt can be hurt by interest rate hikes, which typically accompany any upswing in inflation. But because floating-rate debt resets the effective coupon payments on a regular basis, this asset class can be attractive for those looking to avoid interest rate risk and adjust coupon payments received with changes in inflation. Floating-rate debt will often increase the nominal yield along with inflation, meaning that investors can still achieve a real return.

Investors holding fixed-rate debt, on the other hand, may see the rate of inflation eclipse the coupon payments on their debt, meaning that the real return offered has gone negative.

The iShares Barclays TIPS Bond Fund is easily the most popular option in the Inflation-Protected Bonds ETF Database Category. TIPS are a popular inflation-fighting tool since they are extremely low-risk (they are backed by the U.S. government), and because their par value rises with inflation (as measured by the Consumer Price Index). Additionally, the interest rate for TIPS remains fixed; interest is paid semiannually and is exempt from state and local income taxes. When TIPS mature, the noteholder is paid the adjusted principal or the original principal, whichever is greater.

TIP provides investors with broad-based exposure across multiple time frames. The fund includes all publicly issued U.S. Treasury inflation-protected securities that have at least one year remaining to maturity. In theory, TIPS are a fool-proof way to beat inflation. However, many experts emphasize the very short performance history of these securities along with other potential drawbacks [see Best Of TIPS ETFs: Expenses, Dividends, and Returns].

STPZ offers more targeted exposure than TIP, focusing on the short end of the maturity curve. Because holdings have a remaining maturity of between one and five years, STPZ will generally offer a lower yield but will also feature less in the way of interest rate risk. This feature can be valuable in inflationary environments, especially in those in which the Fed is raising interest rates.

The majority of investors interested in inflation-linked bonds generally only consider U.S. securities. Expanding internationally may bring both diversification and return-enhancement benefits. Inflationary pressures kick in at different times across the various economic regions around the globe, and thus an international defense against inflation is more appropriate for investors interested in building a truly diversified portfolio.

As the name suggests, this ETF offers exposure to the global TIPS market. Investors who are weary of holding entirely domestic or international TIPS should consider GTIP. The fund offers broad-based exposure to inflation-protected securities from both the U.S. and foreign countries [see also Ten Commandments of ETF Investing].

Gold is one of the most popular inflation hedges because the precious metal has historically shown strength when the dollar encounters weakness (devaluation). Physical exposure also serves as a store of value that tends to perform well in inflationary environments. Gold is also considered a “safe haven” asset class, much like U.S. Treasury bonds, which means that it attracts investment inflows when equity markets are uncertain and plagued with volatility.

IAU is the cheapest gold ETF within the Precious Metals ETF Database Category, charging a mere 0.25%. The ultra-popular (GLD A-), as well as AGOL and SGOL, are other options for physically-backed gold ETF exposure.

This fund offers physically-backed exposure to silver for investors who prefer exposure to the white metal. Silver has an advantage over gold in that it’s used more often in the industrial world and therefore has the potential for more rapid price increases. However, the white metal is typically more volatile than its counterpart, so it comes with a high risk/reward profile.

Another option for achieving exposure to gold is investing in the stocks of companies engaged in the extraction and production of the yellow metal. The profitability of these companies should rise along with the price of gold, making this asset sub-class yet another option for combating inflation. Assuming that gold will perform well when inflation accelerates–which is not necessarily guaranteed–gold miners should deliver solid returns.

Commodities have obvious appeal to protecting against inflation; broad-based natural resource exposure can provide access to an asset class that should perform well in such environments. USCI is one of several ETFs in the Commodities ETF Database Category that offers exposure to a basket of futures contracts. Unlike many competing products, USCI uses a screening methodology to select contracts that focus on the severity of contango and backwardation in futures markets, potentially enhancing returns over the long run by avoiding assets that are facing strong headwinds.

Some investors would prefer to avoid futures-based strategies for commodity exposure, achieving access instead through companies involved in the production of basic materials and hard assets. Similar to gold miners, commodity-intensive companies may see their outlooks improve when natural resource prices begin to rise. Instead of focusing on a narrow segment of commodity producers, HAP casts a wider net; the portfolio includes miners, agribusiness stocks, and oil and gas producers, giving it excellent broad-based exposure to a basket of commodity-intensive companies from around the globe [see also Futures Free Commodity ETF Database Portfolio].

GRES is unique among the ETFs offering exposure to Commodity Producers because it includes sectors such as timber, water, and coal that aren’t found in many similar products. This fund also includes short exposure to global equities as a partial equity market hedge; this compelling feature helps to isolate the returns realized by commodity-intensive companies attributable to movements in the price of raw materials (as opposed to factors that impact broader equity market performance).

When considering possible inflation hedges from the lineup of available commodities, timber probably isn’t the first resource that comes to mind. However, historical evidence suggests that timber can serve as a formidable hedge against rising prices. For example, during America’s last major inflationary period, from 1973 to 1981, inflation averaged just above 9% annually, while timberland values increased by an average of 22% per year.

CUT can be a useful tool in protecting against inflation while also improving overall portfolio diversification, since the asset class bears low correlation with general equity markets. Note that CUT doesn’t invest directly in timber, but rather in timber companies [see CUT holdings].

As mentioned previously, short-term Treasuries are at the core of QAI’s inflation-fighting technique. That’s because this asset class generally serves as a proxy for the rate of inflation, delivering a small real return to investors. SHY, which measures the performance of 1-3 year U.S. Treasury securities, can serve as a great tactical tool for fighting inflation in the short run.

XOP allows investors to establish an oil-intensive defense, offering exposure to companies in the oil and gas exploration and production sector. If inflationary pressures push oil prices up, companies with operations focused on producing this key commodity could see a boost in top-line revenue (and bottom-line earnings).

Similar to funds such as HAP (profiled above), this ETF effectively gives investors indirect exposure to commodities–an asset class that can come in handy when inflation pops up.

A depreciating greenback makes it more expensive to import goods and services, which in turn contributes to an uptick in prices at home. Investors may choose to protect their portfolios by betting against the performance of the U.S. dollar relative to other developed currencies, anticipating that the relationship between these two factors will weigh on the U.S. currency.

UDN offers short exposure to the dollar relative to a basket of developed-market currencies including the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona and Swiss Franc.

Long-term bonds perform poorly in inflationary environments since interest rate hikes make existing debt less appealing. More attractive yields can be realized through freshly-issued debt securities. Thus, investors may choose to short longer-term Treasuries in anticipation of rising interest rates. Investors who don’t have access to a margin account, required for shorting securities, should consider offerings in the Inverse Bonds ETF Database Category.

TBT is one of the most popular products on the market that allows investors to gain leveraged inverse exposure to U.S. treasuries with a remaining maturity of at least 20 years.

This product comes from FlexShares and offers exposure to inflation-protected securities that have an average duration of approximately three years. A duration of three years is relatively short in the fixed-income world, meaning that the fund will have less volatility than some of its longer-term counterparts.

Exposure within the fixed-income corner of the market is very sensitive to interest rates; coupon payments lose their value as rates rise. Investors can protect against the deterioration of their current income streams by investing in floating-rate debt securities, which simply adjust payouts as rates change. BKLN is designed to track the market-weighted performance of the largest institutional leveraged loans based on market weightings, spreads, and interest payments.

Investors should be aware that the majority of BKLN’s holdings are rated BB or lower and have a maturity of seven years or less [see also Senior Bank Loans: High-Yield With Perks].

CCXE provides exposure to stocks in commodity-intensive economies. However, this ETF features a more broad-based exposure to a greater number of countries rich in natural resources. CCXE follows a fundamentally-weighted index that measures the performance of dividend-paying companies from commodity countries selected from the WisdomTree Global Dividend Index.

Historically, currencies of commodity-producing economies have exhibited increased sensitivity to global growth levels. During economic booms demand for raw material surges, sending both the prices of the commodities and the value of related currencies higher. But these currencies have also held up relatively well during periods of slumping commodity prices, losing value in only approximately a third of “down” commodity quarters.

CCX seeks to match total returns reflective of money market rates in selected commodity-producing countries and changes to the value of such countries’ currencies relative to the U.S. dollar.

BWZ is the international alternative to SHY. The fund measures the performance of fixed-rate local currency sovereign debt of investment-grade countries outside the United States that have remaining maturities of one to three years. For investors who believe that short-term bonds should be at the core of an inflation-fighting strategy, this ETF offers a way to extend exposure beyond U.S. borders.

Coffee is one the world’s most traded commodities and a popular dietary component for consumers across the globe. At the same time, there is some evidence to suggest that coffee is one of the more effective commodities in inflationary environments. It is an attractive global good that can serve as a reasonable hedge against inflation.

JO is an ETN that offers futures-based exposure to coffee. As such, investors should note the potential credit risk components and the potential for returns to deviate from a hypothetical spot investment. (CAFE B-) also presents an option for exposure to this commodity.

Corn is easily one of the most consumed commodities in the world, and the crop actually makes for a decent inflation hedge as well. This shouldn’t be all that surprising, since food prices tend to be among the earliest to begin heading higher when inflationary environments materialize.

Teucrium‘s CORN is currently the only fund that offers exposure exclusively to corn futures. And unlike most of the products on the market, CORN won’t invest only in near-month contracts. Assets will instead be split between second-to-expire futures, third-to-expire futures, and futures expiring in the December following the expiration month of the third-to-expire contract.

An effective inflation-hedging strategy can be a pivotal component to any well diversified portfolio. As always, we recommend investors look under the hood of any ETF prior to making an investment.

Disclosure: No positions at time of writing.