Are clients worried about inflation? More importantly, what are advisors doing to quell those fears?
Inflation actually declined 0.1% last month for the first time in nearly 30 years, but even some Federal Reserve officials disagree over the outlook. James Bullard, the president of the St. Louis Federal Reserve Bank, said this week that the risk of inflation still looms.
So if your clients agree with Bullard and come to you for help in protecting their portfolios against inflation, one option at your disposal comes courtesy an interesting new fund from IndexIQ, albeit with the uninspiring name of IQ CPI ETF. Adam Patti, the company's chief executive officer, said that the fund is designed with a simple goal: to overcome the inadequacies of most other inflation-indexed ETFs by truly indexing for inflation.
The easiest inflation indexed investment would be simple TIPS bonds, Patti said. But if clients are more interested in an inflation-indexed ETF, then they become subject to the whims of the market instead of just receiving inflation plus some nominal return.
Patti said his analysis of inflation, going back to about 1910, showed that short-term bonds were the best proxy for inflation. Therefore, short-term bonds make up the core of the fund, around 80% of the total holdings, surrounded by other things including equities, commodities, currencies and even real estate. The fund is designed to return two to three percentage points above inflation, he said.
Those other investments surrounding the short-term bond core do not surprise Paul Justice, an ETF strategist at Morningstar [MORN].
He said that inflation-minded investors can consider a wider array of investments by simply broadening their thinking when it comes to inflation protection. Investments that are not necessarily indexed for inflation can still be a good hedge against the threat of inflation, he said.
Gold is one such example. Another one is consumer stocks that have “pricing power,” or the strength to raise prices when inflation occurs.
Coca-Cola is one example he used, as it can usually raise prices modestly in an inflationary environment without a discernable decline in sales. Commodities can also be a good hedge for inflation since they are fungible, he says. That is, if inflation is high in one country, a barrel of oil can be sold in another.
But these various strategies are not a guarantee of protection from inflation, Justice said. Indeed, there is no perfect way to offset the effects of what he calls the “silent killer” of investments.
Investors are definitely worried about the possibility of inflation in the future. But there are some mixed messages investors can get if they listen to the pundits, or even try to read the tea leaves themselves, Justice said. And those messages can be especially perplexing today because some of them are polar opposites, he said.
For instance, people are worried about inflation and deflation at the same time, both for seemingly sound reasons. Inflation worries come from all the stimulus money sloshing around the system, while deflation worries stem from unemployment and consumers de-leveraging.
As for the CPI fund from IndexIQ, Justice said he knows of the fund, and said there are no others in the market doing exactly the same thing to his knowledge, but he still wonders if it will entice many investors. For as much as people may be worried about inflation, the complexities involved in trying to offset it may well turn people off, he said.
But that just creates an opportunity for advisors. When clients come to talk about inflation, an advisor needs to be prepared to have an intelligent conversation to ease their fears and know their various options.