Headlines of late have been filled with news about inflation, from rising commodity, precious metals and gas prices to higher prints of the consumer price index. Traditionally investors have looked to US real estate, commodities and US TIPS as the vehicles of choice to help protect against inflation. As news of rising foreign inflation reaches the US, investors may now be asking if they need to think about global inflation in the context of their portfolios. Is global inflation different than US inflation? Could investing in assets that help protect against global inflation increase a portfolio’s overall efficiency? Am I missing an opportunity?
Whether they realize it or not, most US investors are already exposed to global inflation through their investments in US companies with interests abroad, foreign stocks and bonds, and commodity-sensitive investments. US investors are also already exposed to the impact global inflation has on prices as many goods sold in the US are produced elsewhere.
Going forward, global inflation may be an increasingly important part of portfolio construction as recent monetary policy raises the risk of inflation abroad. Inflation rates have historically differed between the US, developed markets and emerging markets; we believe they will continue to do so over the next few years. Certain countries—the UK, Canada, India and Brazil, for example—may be particularly vulnerable to higher inflation.
In all, just as investors consider US TIPS to help protect US portfolios against inflation, they should consider global inflation-linked bonds to help protect their global portfolios.
So what role can inflation-linked bonds play in an investor’s portfolio? There are three main strategies to consider:
- Help protect against inflation. Global inflation-linked bonds can help to hedge a portfolio against rising prices across the globe. If, for example, an investor’s global portfolio has a 10% allocation to US TIPS, one could argue that foreign inflation-linked bonds should comprise a healthy portion of that 10%, as part of a broader inflation protection strategy.
- Further diversify a multi-asset class portfolio. Global inflation-linked bonds have low historical correlations to other major asset classes, which can add further diversification to multi-asset class portfolios. Over the past 10 years, global inflation linked bonds have had a correlation of less than 0.50 relative to a number of core asset classes such as large and small cap US stocks, emerging market stocks, and commodities (10-year correlation as of 3/31/11).
- Express a tactical view on future inflation or foreign currencies. Investors can use global inflation-linked bonds to express views on future inflation. An investor who believes that global inflation will accelerate could position their portfolio to take advantage of the opportunity by increasing their global inflation linked bond exposure.
The bottom line for investors? Be aware of global inflation trends and the impact they can have on a portfolio. Take a closer look at investments like global inflation-linked securities that may help cushion a portfolio from rising inflation. A global investment approach requires a global inflation solution.
Potential iShares solutions:
- GTIP – iShares Global Inflation-Linked Bond Fund
- ITIP – iShares International Inflation-Linked Bond Fund
Diversification may not protect against market risk. Bonds and bond funds will decrease in value as interest rates rise. TIPS can provide investors a hedge against inflation, as the inflation adjustment feature helps preserve the purchasing power of the investment. Because of this inflation adjustment feature, inflation protected bonds typically have lower yields than conventional fixed rate bonds and will likely decline in price during periods of deflation, which could result in losses.
In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.
Narrowly focused investments typically exhibit higher volatility and are subject to greater geographic or asset class risk. Inflation-linked investments may be subject to credit risk, which refers to the possibility that the debt issuers will not be able to make principal and interest payments. An inflation-linked bond fund’s income may decline due to a decline in inflation (or deflation) or due to changes in inflation expectations.