The need for inflation protection within investor portfolios has taken on added significance in recent weeks, as the Russian invasion of Ukraine accelerates already historically high global price pressures.
With geopolitical unrest likely to persist in the near term, assets with a proven ability to perform well in heightened inflationary environments could be set to witness increasing investor demand over the course of the year.
According to Vince Childers, head of real assets multi-strategy at Cohen & Steers, investors could shun traditional asset classes as inflationary pressures continue to bite. With real interest rates in deeply negative territory and equity valuations still rich on many metrics, Childers believes both stocks and bonds offer little margin of safety to defend against a prolonged, adverse inflation environment.
Childers says navigating near-term monetary policy is likely to become increasingly delicate, as the Federal Reserve and other central banks balance rising inflation and slowing growth – two economic conditions amplified by Russia’s invasion of Ukraine.
“Higher inflation and slower growth raise the prospect of stagflation,” he says. “Stagflation is historically a good period for real assets relative to traditional assets such as stocks and bonds.”
Here, Childers sees robust growth potential and strong inflationary protective qualities across a number of major segments within real assets – such as resource equities, real estate and infrastructure.
While rising energy costs have been a major driver of inflation in recent months, the war in Ukraine has since driven oil and gas prices up further. Within the resource equities space, Childers expects US energy companies to witness accelerating demand as the war reshapes global supply.
“Western economies are likely to look for alternative sources of energy, which will support North American production and exports of energy to Europe,” Childers says.
With substantial capital flow expected to move to renewables, Childers also expects faster demand growth for metals – namely platinum, palladium and aluminium.
Reduced volatility and greater resilience
When it comes to investments offering protection from inflation, real estate is one of the most widely held asset classes. This is for good reason, according to Childers, who pointed to recent research from Cohen & Steers showing real estate typically outperforms by 2.5% for every 1% that inflation exceeds the prior-year estimate.
“Real estate is a meaningful component in any dedicated real assets allocation due to its attractive balance of expected risk-adjusted return potential and inflation sensitivity,” Childers says.
One of the world’s largest Reit investors, Cohen & Steers’ positioning in Europe is aimed at areas displaying structural growth or defensive characteristics – such as logistics, healthcare and self-storage. Childers expects these segments of the real estate market to be better able to tolerate an environment of falling growth and rising rates.
Another popular destination for investors seeking inflation-proof returns in recent years has been listed infrastructure. Childers says infrastructure has historically offered equity-like total return potential, but with reduced volatility and greater resilience in down markets versus global stocks, as well as inflation-linked revenues in select subsectors.
“For example, with regulated utilities, inflation is typically factored in when determining consumer rates and included in utility project costs that can affect a utility’s rate base. With toll roads and airports, local government agreements allow service rate increases based on fixed amounts above the inflation rate.”
While the impact of inflation has not been a major consideration for investors over the past decade, the environment has drastically changed in recent months. Should bonds and equities struggle to provide the necessary protection, it may force investors to seek shelter in alternative asset classes as 2022 progresses.