How to Make Your Portfolio Inflation-Proof

Inflation in the U.S. has continued to increase. The CPI print for January, released last week, showed that the year-over-year headline CPI was 7.5%, exceeding analyst expectations of 7.3%. While a spike in inflation was widely anticipated as part of the COVID recovery, the scope and magnitude proved to be greater than most had anticipated. 

FlexShares’ analysts expect inflation to moderate to an annualized rate of 1.7% over the next five years. They note, however, “that masks elevated inflation over the next year-plus that then falls to disappointing inflation in the back years,” according to a FlexShares insight.

The unfortunate and unavoidable fact is that reconciling the confluence of disrupted supply chains, persistently high consumer demand, and the flood of money arising from rising wages, historically low interest rates, and government stimulus payments is no simple task, the insight claims.

Northern Trust’s Capital Markets Assumption Working Group also sees reason for optimism. While the “demand drivers” witnessed over the past year — importantly, the massive infusion of government stimulus — will not persist, the “supply enablers” introduced during the pandemic will, according to FlexShares.

“Supply enablers” include productivity enhancers that the pandemic forced companies and workers to adopt. One outcome of the pandemic has been the fuller realization of the power of technology. For a sense of the productivity impact, U.S. real economic output eclipsed its pre-pandemic high in the second quarter of 2021 — achieved with 6.2 million (or 4.1%) fewer workers, according to FlexShares.

When looking at equity investments, specific areas of the economy may experience longer-term benefits from rising demand.

A diversified allocation across REIT sectors may provide an opportunity to capitalize on rising rents in residential properties, as well as changes that businesses are making to address changes triggered by the pandemic, according to FlexShares.

Funds to consider include the FlexShares Global Quality Real Estate Index Fund (GQRE ) and the FlexShares STOXX Global Broad Infrastructure Index Fund (NFRA B+).

Inflation cycles tend to play out differently across different commodity and natural resources sectors, and concentration in one area may lead to unwanted volatility. The FlexShares Morningstar Global Upstream Natural Resources Index Fund (GUNR A) offers exposure to the natural resources supply chain.

Additionally, certain fixed income sectors may help to soften the negative impact on total returns. 

Looking to longer-term, high-yield bonds may help to mitigate the impact of persistent inflation because of their lower correlation to U.S. Treasury rates, according to FlexShares.

A strategic allocation to TIPS might also make sense depending on an investor’s risk tolerance and long-term investment strategy, according to FlexShares.

Funds to consider include the FlexShares iBoxx 3-Year Target Duration TIPS Index Fund (TDTT A-) and the FlexShares iBoxx 5-Year Target Duration TIPS Index Fund (TDTF B+).

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