Seeking Alpha

Funds That Do Well When The Dollar Is Falling And Inflation Rising

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Includes: ECF, EOD, FIREX, FPHAX, FPNIX, FRIFX, FSRRX, HPI, IAU, ICLN, IGIB, IMCDX, JXI, MCR, OPTAX, PCSFX, PIO, PRMTX, PRSNX, PTTFX, TOLZ, VEMBX, VFIIX, VTABX
by: Charles Bolin
Charles Bolin
Medium-term horizon, macro, portfolio strategy, ETF investing
Summary

U.S. Valuations are high, inflation is low but rising, and the dollar is weakening. This article looks at global funds and funds that do well in this environment.

Nine Global, Real Estate, Infrastructure, Clean Energy, Commodity and Materials Funds that are relatively lower risk and trending higher are evaluated.

Hypothetical Very Conservative, Conservative, and Moderate Portfolios are created using the Mutual Fund Observer screen to the Lipper Database to select the funds and Portfolio Visualizer to assign allocations.

Funds are selected based on Risk, Risk Adjusted Returns, Momentum, Income, and Quality Factors.

Introduction

This exceptionally long business cycle appears set to emerge from its third growth slowdown and has now reached the stage where a cyclical bull market in commodities can be expected. We are prepared to make timely adjustments to our investment portfolios to take advantage of this potentially inflationary environment.

- Our Business Cycle Work Is Close to Signaling a Stage III. Guess Which Market That’s Bullish For?, Martin Pring

Each month, I extract about a thousand funds from the Lipper database using the Mutual Fund Observer screens. I rate these funds based on Risk, Risk Adjusted Returns, Momentum, Yield, and Quality. This month, I look for short-term trends looking for inflection points as the U.S. markets are highly valued, global growth is growing while growth in advanced economies is slowing. The current environment also has rising employment costs, declining profit growth, inflation rising modestly, and the dollar weakening.

Growth among advanced economies as a group is anticipated to slip to 1.4% in 2020 in part due to continued softness in manufacturing. Growth in emerging market and developing economies is expected to accelerate this year to 4.1%... U.S. growth is forecast to slow to 1.8% this year, reflecting the negative impact of earlier tariff increases and elevated uncertainty. Euro Area growth is projected to slip to a downwardly revised 1% in 2020 amid weak industrial activity.

- Global Growth: Modest Pickup to 2.5% in 2020 amid Mounting Debt and Slowing Productivity Growth

Dollar Weakness

Short of escalating tensions in the Middle East or a pullback in stocks, the catalyst for higher gold prices—and, indeed, commodity prices in general—may very well be a substantial weakening of the U.S. dollar. On Tuesday, the U.S. Dollar Index experienced a “death cross,” a bearish signal that takes place when an asset’s 50-day moving average crosses below its 200-day moving average. We haven’t seen this from the greenback since May 2017.

- Dollar Weakness Could Be the Catalyst Commodities Are Looking For

The dollar is starting to weaken as shown in Chart #1.

Chart #1: Weakening Dollar Value

Source: St. Louis Federal Reserve

In this article, I look for commodities, basic materials, natural resources, global funds, and real estate that tend to do well when inflation rises and the dollar falls.

Investing In Commodities And Basic Materials

  • Over time, commodities and commodity stocks tend to provide returns that differ from other stocks and bonds. A portfolio with assets that don't move in lockstep can help you better manage market volatility.
  • In recent years, increased demand due to massive global infrastructure projects has greatly influenced commodity prices.
  • Inflation—which can erode the value of stocks and bonds—can often mean higher prices for commodities.

- What is commodity investing? Fidelity

In this environment, I look for funds that will reduce the volatility in portfolios while maintaining decent returns and providing income. This article looks at reducing exposure to highly valued U.S. stocks into funds that may be less correlated to the U.S. market.

Commodity, Basic Materials, Natural Resource Funds

As outlined below, sentiment has been tepid at best when it comes to raw materials and the companies engaged in processing oil, gas and other basic commodities. There are a handful of notable exceptions - gold, for instance, has been trending up in recent years. But across the broad, sweep of commodities and energy investors have cooled to the idea that assets in this corner deserve relatively high valuations.

- Deep-Value ETF Report: Commodities/Energy Remain Out Of Favor, James Picerno

These funds are out of favor and typically more volatile than the broader market. Below, I selected nine funds from different Lipper Categories based on their three-month trends. These funds are arranged in Table #1 from least risky, based on the Ulcer Index, from October 2018 until now. The Ulcer Index measures the depth and duration of drawdowns. The Martin Ratio is the risk-free return divided by the Ulcer Index and represents the Risk Adjusted Return. Three-month return represents momentum. The S&P 500 has an Ulcer Index of 4.4. The blue shaded funds are generally less "risky" than the S&P 500, the red shaded funds are generally more risky than the S&P 500 based on the past 15 months.

Table #1: Trending Global, Material and Commodity Funds.

Symbol Name MAXDD% Ulcer Index Martin Ratio RTN 3 Months
FSRRX Fidelity Strategic Real Return -5.2 1.3 1.6 3.6
TOLZ ProFunds Global Infrastructure -9.4 3.4 1.8 3.6
SWASX Schwab Global Real Estate -9.3 3.5 1.9 5.4
FIREX Fidelity International Real Estate -9.9 3.9 1.9 8.4
PIO Invesco Global Water ETF -11.8 4.4 2.0 10.9
IAU BlackRock iShares Gold Trust -11.9 5.5 1.1 2.5
ICLN BlackRock iShares Global Clean Energy -16.7 6.3 2.0 8.5
DBC Invesco DB Commodity Index Tracking -18.9 10.4 -0.3 7.9
MXI BlackRock iShares Global Materials ETF -20.0 10.5 -0.1 8.9

Source: Created by the Author Using Mutual Fund Observer

These ratings are dependent upon the time period and if we are at an inflection point of moderately rising inflation and falling dollar these funds may have higher risk-adjusted returns and lower volatility over the course of 2020. For grins and giggles, I created a portfolio of these funds equally weighted. I advise not owning a concentrated portfolio like this. Still, for illustrated purposes, this portfolio would have returned 25% in 2019. I create three portfolios using some of these funds later in this article.

Table #2: 2019 Performance of Equal Weighted Highlighted Funds

Source: Created by the Author Using Portfolio Visualizer

The efficient frontier for these funds in 2019 is shown below.

Chart #2: Efficient Frontier of Highlighted Funds

Source: Created by the Author Using Portfolio Visualizer

Markets Overview

Table #3 shows the top-ranked categories over the past two years based on Risk, Risk Adjusted Returns, Momentum, Yield and Quality. A component of each of these factors is shown in the table. APR is the annualized return over the past two years and Bear is the average performance during the 2000 and 2007 bear markets. What we can get from the table is that Bucket #2 funds, which is mostly intermediate bond funds, has low price trends due to the steady or rising interest rates. Bucket #4, which are riskier domestic funds, have had a strong rise over the past three months and two years, and I have reduced exposure to this Bucket. Some inflation-resistant funds are both low risk and have decent three-month trends. Basic Materials and Commodities have strong three month trends and higher risk. I favor global bonds and stocks because of strong trends and lower valuations. In the latter stages of an expansion, I always keep an eye out for good defensive funds.

Table #3: Top Rated Lipper Objectives

Source: Created by the Author Using Mutual Fund Observer

Table #4 contains the top-ranked funds separated by Vanguard, Fidelity mutual funds and no-load, no-fee mutual funds from Schwab, closed end fund and exchange traded funds. CEFs with high premiums are excluded. I include exchange traded funds in the funds universe that are rated highly by at least three of Mutual Fund Observer, Market Edge, FactSet, XTF, Ned Davis and Morningstar. Table #4 is my quick look at a fund shopping cart.

Table #4: Top Rated Funds in Top Rated Lipper Objectives

Bucket 1: Safety Vanguard Fidelity Schwab CEF ETF
1. Ultra-Short Obligations VUSFX TRBUX GSY
2. Short Invest Grade Debt VFSTX PRWBX IGSB
3. Short U.S. Government VSGBX FTSD
4. Short-Intmdt Invest Grade Debt FTHRX THIFX VCSH
Bucket 2: 1 to 2 Years
1. Gen & Ins Muni Debt VWAHX FTABX OPTAX FMB
2. Intmdt Municipal Debt VWITX FLTMX GSMIX MUI MUNI
3. Core Bond VFICX FTBFX PTTFX GTO
4. Intmdt U.S. Gov RMAGX VGIT
Bucket 3: 3 to 4 Years
1. Utility FSUTX MMUFX UTF JXI
2. Income VWINX FASIX DIFAX AOK
3. Balanced VASIX FBALX JABAX
4. Health/Biotechnology FSMEX SHSAX XLV
Bucket 4: 4 to 5 Years
1. Equity Income VDIGX FEQIX PQIAX FDVV
2. Growth & Income VTHRX FIKFX TAIAX EVT ONEY
3. Telecom FWRLX PRMTX FCOM
4. Growth VTCLX FDGFX PRWAX ASG MGV
Inflation Resistant
1. Real Return FSRRX
2. Energy MLP EMLP
3. Global Nat Resources VGENX PIO
Commodities, Materials, Precious Metal
1. Basic Materials MXI
2. Commodities ARCIX PALL
Yield
1. Sector Equity BME
2. High Yield Muni Debt ORNAX NMZ HYMB
3. Income & Preferred Stock HPI
Global & International Bonds
1. Global High Yield RPIHX HYLS
2. Global Income PRSNX EVG HOLD
3. EM Hard Crncy Debt IMCDX EMD VWOB
Global & International Equity
1. Intern Real Estate VGRLX FIREX PXRCX DRW
2. Global Real Estate CSSPX REET
3. Global Financial Svcs PGF
4. Global Health/Biotech VGHCX FPHAX GGHCX IXJ
Defensive
1. Alternative Credit Focus FPNIX
2. Specialty/Miscellaneous SHE
3. Alternative Event Driven MERFX MNA

Source: Created by the Author Using Mutual Fund Observer

The top funds per Lipper Objective plus the nine funds highlighted in this article can be found at this link to Portfolio Visualizer. This is where I start pre-screening the funds.

January Model Portfolios

The three January Model Portfolios are compared to the Vanguard Wellesley Income Fund in Chart #3. The three model portfolios maximize return since October 2018 constrained by the following volatility: Very Conservative (3.5), Conservative (5.5) and Moderate (8.5). The rules that I used to create the portfolios is that no fund can have more than 10% of the portfolio value except for sector and higher risk funds which could have no more than 5% and each portfolio must contain at least four of the highlighted funds. The link to Portfolio Visualizer is provided here so that interested readers can customize to their preferences.

Chart #3: Performance of Three Hypothetical Portfolios

Source: Created by the Author Using Portfolio Visualizer

The closed end funds are MCR, EOD, PML, ECF, and HPI which meet screening based upon discounts/premiums, fund size among other factors. PML has a premium of 23% and I should have excluded it. You may also notice that Invesco DB Commodity Index (DBC) and Tracking BlackRock iShares Global Materials ETF (MXI) did not make it into the Model Portfolio. The trend in returns are not established enough and the volatility is too high. The Sortino Ratio is the risk-free return divided by downside deviation. The table is sorted from highest risk-adjusted return to lowest.

Table #5: Allocations in Hypothetical Portfolios and 2019 Fund Performance

Symbol Name Very Consrv Consrv Moderate Rtrn Sortino
PCSFX Principal Capital Sec 10% 10% 8% 17% 94
MCR MFS Charter In Trust 5% 5% 25% 44
FRIFX Fidelity Real Estate Inc 5% 18% 28
IMCDX Voya Em Mrkts Corp Dbt 5% 5% 5% 14% 25
IGIB iShares Intrmdt-Tm Corp 10% 10% 15% 23
EOD Wells Fargo Glbl Div 5% 36% 22
VEMBX Vanguard Emrg Mrkts Bd 10% 10% 18% 18
OPTAX Invesco Opp Muni 10% 9% 12% 16
PTTFX T. Rowe Price Total Rtn 10% 10% 10% 15
PML Pimco Muni Inc Fund 5% 5% 5% 26% 15
TOLZ ProShares Global Infras 5% 27% 12
ICLN iShares Glbl Cln Enrgy 5% 5% 5% 44% 12
FIREX Fidelity Intl Real Estate 5% 5% 5% 28% 12
FPNIX FPA New Income 5% 4% 10
VFIIX Vanguard GNMA Inv 10% 6% 9
PRSNX T. Rowe Pr Glbl Multi-Sctr 10% 6% 10% 9
ECF Ellsworth Growth & Inc 5% 5% 47% 8
JXI iShares Global Utilities 5% 5% 5% 24% 8
FSRRX Fidelity Strtgc Real Rtrn 5% 10% 6
PIO Invesco Global Water 5% 5% 36% 6
FPHAX Fidelity Select Pharm 5% 32% 5
VTABX Vanguard Total Intl Bd 10% 8% 5
PRMTX T. Rowe Pr Com&Tch 5% 34% 5
HPI John Hancock Prfrd Inc 2% 31% 4
IAU iShares Gold Trust 5% 5% 5% 18% 3

Source: Created by the Author Using Portfolio Visualizer

My preference during this late stage of the business cycle with high valuations, as someone nearing retirement, is to lie somewhere near the Very Conservative portfolio. Returns were good in 2019 due to falling interest rates.

Table #6: 2019 Performance of Hypothetical Portfolios

Very Conservative Conservative Moderate
CAGR (Annualized Return) 15% 21% 26%
Standard Deviation 3% 4% 7%
Sortino Ratio (Risk Adj Return) 72 499 39
US Stock Market Correlation 0.4 0.7 0.8
US Stocks 5% 8% 19%
Intl Stocks 10% 12% 17%
US Bonds 42% 31% 13%
Intl Bonds 25% 24% 18%
Other 9% 8% 9%
Cash 4% 2% 2%
Unknown 5% 15% 22%
Total Bonds and Cash 71% 47% 33%

Source: Created by the Author Using Portfolio Visualizer

It can be seen that some funds in Chart #4 have similar returns as those with higher volatility. There is little incremental return for taking on higher volatility.

Chart #4: Efficient Frontier of Funds In Hypothetical Portfolios

Source: Created by the Author Using Portfolio Visualizer

Bucket Approach Review

Below is a review of what investment bucket the funds fit into. It confirms my suspicions that Risk, Risk Adjusted Return, Income, Momentum, and quality Factors are tilting toward global funds, income, and Inflation protection. For a diversified portfolio, I require more funds in Bucket #1, #2, and #3 than shown in the table.

Table #7: Bucket Classification

VFIIX Vanguard GNMA Inv Bucket #1
OPTAX Invesco Oppenheimer Rochester AMT-Free Municipal Fd A Bucket #2
PTTFX T Rowe Price Total Return Bucket #2
JXI BlackRock iShares Global Utilities ETF Bucket #3
PRMTX T Rowe Price Communications & Technology Bucket #4
IAU BlackRock iShares Gold Trust Commodities
FPNIX FPA New Income Defensive
IMCDX Voya Emerging Markets Corporate Debt P Global Bond
VEMBX Vanguard Emerging Markets Bond Inv Global Bond
PRSNX T Rowe Price Global Multi-Sector Bond Inv Global Bond
VTABX Vanguard Total International Bond Index Admiral Global Bond
EOD Wells Fargo Global Dividend Opportunity Global Equity
TOLZ ProFunds ProShares DJ Brookfield Global Infrastructure ETF Global Equity
FIREX Fidelity International Real Estate Global Equity
FPHAX Fidelity Select Pharmaceuticals Portfolio Global Equity
PCSFX Principal Capital Securities S Income
MCR MFS Charter Income Trust Income
IGIB BlackRock iShares Intermediate-Term Corporate Bond ETF Income
ECF Ellsworth Growth and Income Ltd Income
HPI John Hancock Preferred Income Income
FRIFX Fidelity Real Estate Income Inflation
ICLN BlackRock iShares Global Clean Energy ETF Inflation
FSRRX Fidelity Strategic Real Return Inflation
PIO Invesco Global Water ETF Inflation

Source: Created By the Author

Mutual Fund Observer Portfolio

Table #8 contains the results of the Mutual Fund Observer Portfolio Tool for the Conservative Portfolio. Each month, I look for one or two funds that are not performing well on a risk-adjusted basis and what I may want to replace them with. The Clean Energy Fund and Global Water Fund have risen too far and too fast for me to be interested in buying them, and as mentioned earlier the PIMCO Municipal Income has too high of a premium for my taste. The rest are the types of funds that interest me. Note that the portfolio has a yield of nearly 4%. As can be seen in the table, I prefer funds with proven track records and lower risk.

Table #8: Mutual Fund Observer Portfolio Analysis of Conservative Fund

Source: Created by the Author Using Mutual Fund Observer

Fund Spotlight - Fidelity Strategic Real Return Fund (FSRRX)

The Fidelity Strategic Real Return Fund (FSRRX) has 26% invested in inflation protected debt, 27% in floating rate debt, 25% in commodities, and 13% in real estate debt. It has returned 10% in the past year. The composition is about half U.S. Government and half rated "B" or "BB." The Fund is 14 years old and lost 22% during the last recession, but returned 6% annualized since then. Morningstar only rates the Fund with one star, but Mutual Fund Observer gives it a Risk Rating of 2 (second lowest risk) and an MFO Rating of 5 (highest) over the past two years. I purchased it because of it's moderate exposure to commodities.

Chart #5 shows it compared to iShares Gold Trust (IAU) which is another hedge against inflation that I own.

Chart #5: Fidelity Strategic Real Return Compared to iShares Gold (IAU).

ChartData by YCharts

Closing

This past month, I had a change in employer-sponsored plans which was a good opportunity to reflect on what I owned in that portfolio. I created a replacement portfolio based on the trends discussed in this article. I chose more global and international funds including an emerging market fund. I tested the planned portfolio in the MFO Portfolio Tool and it classified the portfolio as Moderate (3) whereas my preference is to be more conservative. I reduced stock exposure.

I own a gold ETF and inflation protected bonds in case the trends in this article continue. I believe the stock markets are overbought and there may be a dip in the next few months. I placed a limit buy order for a commodity fund and an international stock dividend fund in anticipation of this dip. I like moving slowly when trends are emerging, but not firmly established. The hypothetical portfolios that I build each month are a moving target to work towards as each month confirms or disproves current assumptions.

Disclosure: I am/we are long VFIIX, IAU, FPNIX, VEMBX, PRSNX, VTABX, FSRRX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am an engineer with an MBA nearing retirement and not an economist nor an investment professional. The information provided is for educational purposes and should not be considered as advice. Investors should do their due diligence research and/or use an investment professional. In September 2019, I began contributing to the Mutual Fund Observer monthly newsletter. I am employed in the precious metals industry.