Evaluating Inflation Hedges

More diverse than expected

July 2022. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Despite being different metrics, CPI and breakeven inflation rates exhibited the same trends since 2003
  • The securities with high betas to inflation come from diverse sectors, not just from energy and commodities
  • Portfolios often feature hidden inflation exposure that should be revealed via factor exposure analysis

INTRODUCTION

The Bundesbank estimated that Germans hoarded about EUR 200 billion of cash at home and deposit boxes at banks as of 2020. Aside from the risk of losing money at home through theft, water damages, or fire, cash loses its value daily in real terms through inflation.

In 2020, inflation was less than 1% in Germany, but that increased to close to 10% in 2022 due to the global supply chain issues and the war in Ukraine. Stated differently, at the current inflation rate, more money is lost in Germany in real terms by hoarding cash than invested in German startups by venture capital funds, which was EUR 19.7 billion in 2021 according to Dealroom. It is terrible for savers and the economy.

Most investors are aware of the damage inflation does to their portfolios, but protecting a portfolio against inflation is not simple. In this research note, we will explore the securities with the highest inflation-hedging properties (read Building an Inflation Portfolio Using Asset Classes).

INFLATION METRICS

One of the challenges of inflation is that it is measured differently across and within countries. The official statistics are backward-looking, but there are also forward-looking ones derived from surveys or markets, as well as shadow statistics from market participants that do not trust the official data. Unfortunately, this data abundance makes it difficult to form a clear picture of the current inflation rate.

In this article, we focus on two measures namely the United States Consumer Price Index for All Urban Consumers (“CPI”) and the United States 10-Year Breakeven Inflation Rate (“BEIR”). CPI is available as a monthly time series, is seasonally adjusted, and represents the price change of a broad basket of goods and services, includ