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Chronicles of an Allocator

Chronicles: May 2021

Issue 15, May 2021

Dear Investment Professional,

Though supply shortages had already caused prices to creep up on products ranging from Buffalo chicken wings¹ to mattress foam², last week’s Consumer Price Index (CPI) report confirmed that inflation in the United States has indeed arrived. Despite the known base effects of the year-on-year comparison, the 4.2% jump reported from last April had many economists stumped³ and investors around the world seeking reliable hedges against future price increases.

In this month’s Chronicles of an Allocator, we’ve brought together recent research and commentary examining a known favorite of inflation-wary investors around the world: real assets. As most readers might expect, not all real assets will hedge equally, and niches with longer-term stories, like private infrastructure that supports the clean energy transition, are expected to produce better results than others.

The CAIA Content Team

John L. Bowman, CFA, Senior Managing Director, Twitter, LinkedIn

Keith Black, PhD, CFA, CAIA, FDP, Managing Director Content Strategy, Twitter, LinkedIn

Guowei Jack Wu, CFA, CAIA, Content Director, APAC, Twitter, LinkedIn

Aaron Filbeck, CFA, CAIA, CIPM, FDP, Director, Global Content Development, Twitter, LinkedIn

In other news...

Fundamentals of Commodities - The Inflation Series

If you’re interested in expanding your toolkit to help you manage higher levels of inflation, join CAIA Association for our upcoming Fundamentals of Alternative Investments (FAI) series on real assets. On Wednesday, June 2, at 12 PM EDT, Keith Black and Katherine Kaminski, PhD, CAIA, Chief Research Strategist and Portfolio Manager, AlphaSimplex Group, will kick off the three-part series with a market update on commodities and the role they play in asset allocation and inflation protection.

All That Glitters

Despite the expansion of access to other real assets and inflation-hedging options, gold remains one of the more popular choices for investors around the world. According to the World Gold Council, despite its popularity in times like these, the historical relationship between gold prices and the U.S. CPI has been relatively weak, making gold “somewhat of a blunt tool” with regard to inflation. Nevertheless, given its stronger relationship with the U.S. money supply, gold may still prove a useful long-term diversification tool within a portfolio.

Too Much $ + Too Few Goods

In a recent blog post, CAIA Association’s Keith Black examined the potential of real assets—including farmland, timberland, crude oil, gold, and copper, among others—as diversifiers within a traditional portfolio. He notes that within the last 30 years, “the lowest returns to stocks and bonds were experienced during the 25% of quarterly periods with the greatest increase in inflation, while the highest returns to real assets came during the times when stock and bond returns are at their weakest.” Due to inflationary pressures and potential increases in interest rates, stocks and bonds seem primed for sustained underperformance. Together with the likelihood that many investors remain underweight commodities, that means there’s still room for portfolio changes as inflation surpasses past estimates.

Diversifying Within Commodities

Most investors know that commodities as a broad asset class can hedge against inflation relatively well; however, when inflation is driven by price spikes in specific commodities, such as food and energy, that hedging can be even more effective. According to NN investment partners, though commodities have been less appealing to investors for some time, thanks to a mix of inflation, COVID-19, political tailwinds related to global inequality, and sector-specific factors, now may be the ideal time for investors to consider new allocations to certain commodities.

The Heterogeneity of Real Assets

It’s generally accepted that real assets tend to be good bets for a portfolio when inflationary pressures are high; however, the COVID-19 pandemic, along with other longer-term shifts related to energy markets, have created structural changes in our economies that are creating added nuance for investors. In a recent outlook by Verus, we learn about the dispersion within asset classes such as REITs and private real estate, which have been affected by the recent changes in how we work and live, as well as the reasons why value-add infrastructure and mining may offer more promise overall. Meanwhile, investors in timberland and agriculture may face some notable challenges this year.

Innovating in Infrastructure

Australia’s QIC has been seeking innovative ways to invest in infrastructure for much longer than current inflation worries have shaken global markets. In a recent interview on the Free Money podcast, QIC’s Ross Israel discusses the opportunities available within the sector, highlighting strategies and tech-enabled tactics, such as asset recycling and digital twinning, that have helped the government-owned firm maximize its returns over the years. In a recent paper, QIC also made the case for increased investment in the Hydrogen Economy⁴, an area of the infrastructure market that is expected to see heightened demand in the next decade.

Revisiting Benchmarks for Unlisted Infrastructure

Despite the consistent returns and diversification potential that might be gained by investing in private infrastructure, the listed or appraisal-based indexes that many use as proxies for these unlisted assets often fail to capture their true potential. In this study by EDHECinfra, we see how the use of these proxies may undermine the strategic asset allocation process, limiting investments to unlisted infrastructure by those who seek to optimize their portfolios according to certain parameters.

Disrupting the Built Environment

Technological innovation has changed the stakes of the game for infrastructure investors and operators alike, as they must now navigate a landscape where once monopolistic services are giving way to tech-powered alternatives. According to a report by Marsh McClellan, four key innovation categories—data proliferation, connectivity, automation, and sustainability—are generating benefits for investors who can learn new skills and adapt their strategies to meet the disruption.

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