Here is an article discussing inflation and your portfolio.

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Inflation and
your portfolio
Brian Hahn
of Neuberger
Berman explains
how increasing
inflation affects
investments
FEATURECOMMENT
FEBRUARY 2013
PAMMAGAZINE.COM
Protecting today’s wealth for tomorrow
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Brian Hahn, managing director, Neuberger Berman explains how increasing
T
he U.S. Federal Reserve has
moved in unprecedented
fashion over the past few
years to slash interest rates
to historically low levels –
helping to keep inflation
in check – and to pump
money into the financial
system in an effort to spur economic activity.
However, during the continuing economic recovery
there are concerns that an inflation revival may be
surfacing, or even accelerating.
Accelerating inflation can take a toll on investors.
It decreases the value of the domestic currency in
which one holds assets, while also making goods
and services more expensive. Additionally, inflation
can take its toll on many investments. For example,
fixed-rate bonds enjoyed a bull market during the
recent three decades of low inflation and interest
rates; however, they typically have fallen in price at
times of rising inflation.
Today, investors should consider the reality of
higher inflation, which closely correlates to higher
interest rates and can impact portfolio returns. As a
result, some investors may want to consider allocating
funds to several asset classes that are known for their
potential to provide a hedge against inflation.
INFLATION-HEDGING TACTICS
A common strategy for investors to hedge inflation
is by purchasing inflation-linked investments, such
as Treasury Inflation Protected Securities (“TIPS”).
Currently, TIPS appear to carry a high cost, in
terms of swapping a promising return profile from
competing assets for a lower-yielding investment
that provides a potential hedge against rising costs
and prices. Several other asset classes, however, have
shown a high correlation with long-term nominal
inflation and as part of an asset allocation can help
investors potentially mitigate inflation risk while still
maintaining an attractive return profile.
The types of investments that may serve this
purpose in a portfolio include:
Floating Rate Bank Loans: These are generally
senior secured debt instruments with floating rate
Inflation and your
portfolio: time to recalibrate?
coupons. The loans earn a yield that includes both
a spread reflecting credit risk and a floating base
rate, typically the London Interbank Offered Rate
(LIBOR), which is reset on a regular basis, typically
every 30 to 90 days. That frequent reset means that
these loans carry far less interest rate risk than
non-floating rate bonds that pay a fixed interest rate.
Because inflation and interest rates have proven to
be highly correlated over time, floating rate loans
can be a good hedge against inflation.
Commodities: Commodities are basic goods
that can be broken down into five broad groups:
energy, precious metals, base or industrial metals,
livestock and agriculture. Commodities have shown
relatively inelastic supply-and-demand traits: people
still need to fill up their tanks to drive or purchase
food to eat during both inflationary and deflationary
periods. Moreover, tremendous economic growth
in countries such as China, Brazil and India has
triggered strong demand for materials to build roads,
bridges and homes, thus driving up prices. Because of
this demand, prices for commodities have generally
been rising. Commodities do not necessarily have a
positive correlation with the stock market, but they
do have a positive correlation with inflation, thereby
providing a natural hedge against rising prices.
Equities: In some cases, equities can be an
attractive asset class for investors concerned with
spiraling inflation. In general, the idea that diversified
equities can be an inflation hedge is generally only
applicable over longer time horizons, simply because
of the volatility of risk asset classes like equities
over short time horizons. Certain types of stocks,
however, tend to perform better in a rising inflation
environment than others, mainly because their
expense sensitivity to price increases is lower or their
revenue sensitivity is higher, which can be supportive
of profit margins. Industries whose share prices tend
to correlate positively with inflation tend to have high
fixed costs and include late stage cyclical sectors such
as energy, industrial and materials.
For bond investors, it is important to understand
the implications that inflation and rising rates pose
to individual bonds and bond funds (e.g. bond
prices tend to fall during times of high inflation and
FEBRUARY 2013COMMENT
PAM

3. COMMENT
PAM
26
interest rates). That said, interest rate risk can be
managed by adjusting the duration or sensitivity of
a bond portfolio according to the expected direction
of interest rates. Flexible bond management can also
reduce overall portfolio risk by opportunistically
investing across various sectors with potentially less
correlation to movements in U.S. Treasuries.
TAKE STEPS
As previously mentioned, many are concerned that
the actions that have been taken over the past few
years to stimulate the economy could inevitably
result in elevated inflation. While we don’t know
what tomorrow holds, it may be advisable for
investors to consider taking steps today to mitigate
the impact of inflation on their portfolios.
Brian E. Hahn, managing d
wealth a
-
DISCLAIMER:
The
Neuberger Berman LLC
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