How investors can hedge against inflation

Inflation tops the list of investors’ concerns. That is hardly surprising, as inflation has remained above the stated 2% target for years, both in the eurozone and in the United States.

Inflation in the U.S. is estimated to average around 3.5% this year, while inflation in the eurozone is expected to come in at nearly 3%. Japan is the only major economy where inflation is expected to be around 2% this year.

Higher inflation is not entirely unwelcome

Governments are unlikely to say so publicly, but a prolonged period of inflation above the 2% target is not necessarily a problem for them. This is largely related to the sharp increase in public debt in many countries. Spending cuts are politically sensitive, as are tax increases, so allowing part of the debt burden to be eroded by inflation is often the easiest route.

That, of course, comes at a cost to savers, pension funds and consumers. For now, the most likely scenario is that central banks and governments will continue to emphasize the official 2% inflation target, while in practice tolerating inflation of around 2.5% to 3% or even higher.

Fed Chair Warsh struck a distinctly hawkish tone at Jackson Hole late last week, but that does not necessarily mean the Fed will raise interest rates in the near term. That will depend in part on the unemployment data due this coming Friday.

Hedging against inflation

Regardless of whether inflation truly is investors’ biggest concern – geopolitical unrest, excessive government debt and, particularly in Europe, sufficient access to energy also rank high on the list – it certainly makes sense to protect part of a portfolio against the erosion of purchasing power. There are several ways to do so.

First of all, it remains sensible to hold, or add, a ‘must-have ETF’ that benefits from rising commodity prices. This point was highlighted once again last Friday.

Gold is also generally regarded as a useful hedge against inflation, although it is not a perfect one. There have been periods in the past when inflation was high and even gold failed to provide adequate protection.

When it comes to equities, companies with strong pricing power are particularly interesting. Examples include oil majors such as Shell and TotalEnergies, or Exxon Mobil in the U.S., large telecom players such as Deutsche Telekom, and selectively, Big Tech. Real estate also tends to offer reasonably good protection against inflation.

Inflation protected government bonds

Government bonds may seem like a poor choice in periods of higher inflation, but that is not necessarily the case. So-called TIPS – Treasury Inflation-Protected Securities – are linked to the U.S. Consumer Price Index.

This type of instrument is readily available to investors. Most banks and brokers offer the iShares $ TIPS UCITS ETF, although this does involve currency risk. As an alternative, investors could consider the iShares € Inflation Linked Government Bond UCITS ETF.

It is sensible to hedge at least part of a portfolio against inflation. Investors still face plenty of other risks, concerns and issues to consider, with geopolitical conflicts in particular capable of having a major impact on the investment landscape.

Sources: Martin Crum, iex, Andre Taissin