From a multi-asset-class investment perspective, the aim should be to include securities in your portfolios that will respond positively if the inflation trend continues. Some inflation-resilient assets, such as TIPS and commodities, have historically done well in this sort of environment, and investors should be looking to diversify by adding exposure to these asset classes.
There are a few issues to bear in mind with these assets. The value of TIPS decreases when interest rates rise, and commodities can be a volatile asset class. It’s also possible to gain exposure to commodities by buying other international assets, such as equities from commodity-exporting countries (e.g., Australia or Brazil).
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Commodities are often a good hedge against inflation. Most commodities, except precious metals, including oil and food produce are a source of inflation. As a result, investing in commodities seems intuitive when inflation is rising. However, commodities are more volatile than equities. A small catalyst could deflate commodity prices.
Meanwhile, while TIPS directly compensate the inflation rate to investors, rising rates have a negative effect on them.
Investing in commodity-rich economies’ stock markets not only gives you access to the boom in commodity prices, they’re also less volatile.
The above graph compares the performances of four indices—the Bloomberg Commodity Index, the S&P 500 Index, the ASX 200 Index, and the Bovespa Index—since February 2016 when commodities started bottoming out. As you can see, Australian and Brazilian indices outperformed the Bloomberg Commodity Index during that period.
In the next part, we’ll shed light on how various asset classes performed previously when inflation was high.