Protecting Portfolios Against Inflation

Inflation is a perennial threat to the real value of portfolios, even though current inflation rates are low. To protect portfolios against inflation, cash, inflation-indexed bonds, equities, real estate, and commodities are the usual candidates. We examine each, plus other assets and, importantly, various kinds of liabilities, to examine their historical and prospective responses to expected and unexpected inflation. Our article is integrative, bringing together ideas and data from many different sources in one place. Key Findings ▪ The “tightest” hedge against inflation is provided by TIPS (Treasury Inflation-Protected Securities), but they have very low—currently negative—real yields. ▪ Equity indexes, sometimes thought to be an inflation hedge, only “work” over a very long time horizon, and are actually a negative hedge in shorter time frames, falling when inflation rates rise. ▪ The best hedge against inflation—admittedly imperfect—is a diversified portfolio of real assets including TIPS, real estate, commodities used sparingly, and certain equities selected for their ability to pass cost increases through to consumers. International equities and debt may also be a hedge against domestic inflation due to the currency effect.