Alternatives necessary to truly diversify and protect against inflation

  • Describe the challenges from inflation on portfolio construction
  • Explain what alternative assets are
  • Describe risk parity

Commodity ETCs are by nature synthetic (swap-based) rather than physical as it would be impractical to own the underlying assets. 

Careful consideration should be taken around underlying index selection. Understanding the weightings of the commodity basket, also its exposure to any 'roll risk' (the change in value when rolling a futures contract forward for the underlying commodity) is a key due diligence point.

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Listed property securities: property provides a (typically) inflation-linked income from rents and exposure to real capital values, but is vulnerable to vacancies during a recession. 

For retail investors, holding property securities is preferable to direct property funds, in our view, as liquidity (getting your money when you want or need it) is key. While property securities funds look more volatile than direct property funds, this is in part optics owing to the differences in valuation frequency. 

Property securities are valued every second the stock market is open, direct property funds are valued daily, and their underlying property portfolio might be valued monthly or quarterly. While their reported volatility is very different, their underlying economic exposure is the same.

Listed infrastructure securities: tariffs for infrastructure such as toll roads, rail networks, and water/electricity/gas supply utilities are typically inflation-linked. As an asset class, infrastructure is less vulnerable to recession risk than property as it forms part of our background essential spend (as opposed to property which is linked to business cycles). 

As with property we prefer infrastructure securities funds over direct infrastructure funds for liquidity and transparency. 

In our view one of the better ways to get exposure is via multi-asset infrastructure securities (combining both infrastructure debt and equity), which offers lower risk liquid access to the asset class and reflects both its bond and equity-like characteristics.

Listed private market managers

For institutional investors, there is a case for investing in private markets, yet this brings its own liquidity constraints. A liquid way of accessing the private markets theme is to invest in the shares of private market managers. 

This creates the opportunity to benefit from their fee income and the growth in private market assets under management, without tying up capital in actual private market investments, which are illiquid and opaque, and the returns on private market funds are hard to evaluate and are not necessarily cross-comparable. 

Returns are typically measured using an internal rate of return for a specific vintage of fund over a given term. Some private market funds provide a 'public market equivalent' benchmark to enable comparison.