Which Asset Classes Protect Against Inflation?

After a multi-decade pause, the winds of inflation have picked up. Only Treasury Inflation-Protected Securities (TIPS) have been an effective hedge against inflation. Other asset classes have failed to varying degrees.

The unprecedented increase in money creation and extraordinary, expansionary fiscal spending around the globe, combined with the supply constraints from both COVID and the invasion of Ukraine, have led to heightened inflation risk. With this in mind, Eugene Podkaminer, Wylie Tollette and Laurence Siegel, authors of the study, “Protecting Portfolios Against Inflation,” published in the April 2022 issue of The Journal of Investing, examined the historical performance of various assets and liabilities in response to unexpected inflation. Following is a summary of their findings:

  • Anticipated inflation (the inflation rate that is embedded in the yield of the bond when issued) should have no effect on nominal bonds. However, negative shocks (unexpected inflation) are bad for nominal-return bonds.
  • The best hedge against inflation has been provided by TIPS. Their risk is from unanticipated fluctuations in the real rate. Unfortunately, their current real yields are negative, at least out to 10 years (as of April 11, 2022), and even out to 30 years, they are only about 0.25%. Thus, there is significant risk of real rates rising – for example, before the great financial crisis, at the start of 2007, the yield on five- to 20-year TIPS was about 2.5%.
  • Cash has not been a reliable inflation hedge.