Fewer than 10% of the more than 100 mutual and exchange-traded funds aiming to protect investors from inflation have notched gains over the past year, Morningstar Direct data show.
Many of the funds use creative, often complex, strategies, and require other macroeconomic crosscurrents to perform as promoted. When these trades are packaged into a product, they lose nimbleness and can’t shift to offset other risks—such as rising interest rates.
“There’s a lot of dependencies for an inflation hedge to work—it’s hard to have conviction that one would perform during every inflationary shock,” said
Roni Israelov,
chief investment officer of NDVR Inc., a wealth-management firm that uses quantitative portfolio strategies.
Nearly 20 inflation-protection funds have been launched since 2021, the majority being ETFs using sophisticated derivatives strategies. Under the hood of some of the funds, their holdings are anything but similar—that has led to different returns.
Shares of a recently launched fund trading interest-rate derivatives have climbed more than 40% in the past 12 months. Another popular fund using a derivatives strategy lost roughly a fifth of its value, and an inflation-hedging ETF investing in real-asset stocks is down several percentage points.
The S&P 500, in comparison, has declined 6.8%, despite gaining 2.4% in 2023.
Historically, investors have turned to Treasury inflation-protected securities, or TIPS, to lock in bond income while eschewing inflation risk. The bonds’ value fluctuates with the consumer-price index.
But like other bonds, higher interest rates dent their worth: As the Federal Reserve aggressively raised rates last year, the Bloomberg TIPS index declined 12%, the worst performance in its 25-year history.
The largest fund in the inflation-protection universe—Vanguard’s $53 billion short-term TIPS ETF—has fallen 3.6% over the past year. Longer-dated TIPS funds suffered far heavier losses due to their greater sensitivity to the Fed tightening.
Although investors yanked cash from TIPS funds during last year’s rout, newer products have netted inflows. Assets in the entire universe slipped near $264 billion, as of the end of January, from highs near $315 billion less than a year earlier.
The top performer among all inflation-protection funds is the Simplify Interest Rate Hedge ETF, which launched in 2021. Shares of the fund, which uses interest-rate derivatives to bet long-term yields will rise, have climbed 42% in the past year.
Two of the largest newcomers seeking to hedge inflation by creative means haven’t fared as well: The Quadratic Interest Rate Volatility and Inflation Hedge ETF and the Horizon Kinetics Inflation Beneficiaries ETF have declined 19% and 5.1%, respectively, over the past 12 months.
Despite swelling interest-rate volatility, the Quadratic fund stumbled. It bet on higher inflation via a steepening yield curve—meaning yields on longer-dated bonds would rise more than short-end rates. Instead, the bond market is in the midst of its worst yield-curve inversion since 1981, with short-end rates rising above longer-dated ones.
Most funds using strategies other than primarily investing in TIPS charge heftier fees, ranging from $50 to more than $100 annually per $10,000 invested. Meanwhile, the Vanguard Short-Term Inflation-Protected Securities ETF costs $4 each year on the same investment.
“Even if I had great conviction that an inflation hedge is effective, I have to ask whether it’s worth the forgone returns due to fees,” said Mr. Israelov of NDVR. “Fees play a huge role in investor outcomes.”
Horizon’s fund addresses inflation by other means, picking stocks that have exposure to commodities or other hard assets. The fund has beaten the S&P 500 over the past year but hasn’t been able to eke out gains.
Many investors have taken more conventional routes to protect their portfolios.
Rene Reyna,
head of thematic and specialty-product strategy at
Invesco Ltd.
, said his clients have invested in equity subindustry funds, such as the firm’s food and beverage, aerospace and defense, as well as property and casualty insurance products, to hedge against inflation. Shares of all three funds have climbed over the past year.
“Inflation isn’t new—we’re able to look at past analyses to find pockets of the market that have historically done well, but also see what areas may benefit now,” he said. “Investors prefer diversification, but they want themes and ideas that are easier to understand.”
SHARE YOUR THOUGHTS
Do you view these ETFs as inflation hedges? Why or why not? Join the conversation below.
Write to Eric Wallerstein at eric.wallerstein@wsj.com
Copyright ©2022 Dow Jones & Company, Inc. All Rights Reserved. 87990cbe856818d5eddac44c7b1cdeb8
