Robert Amoruso is the Founder and CEO of Gideon Strategic Partners, a boutique investment advisory firm based in Santa Monica.
Investors are struggling to find a safe zone in a turbulent period marked by inflation rising at a level not seen since 1982. Even in the face of recent and expected interest rate hikes in the United States, inflation is likely to remain a significant concern.
But unlike in the early ’80s, there are more alternative investment products that can provide shelter from this economic storm. Private credit, commodities and real estate investment trusts (REITs) can help protect savvy investors from inflation and political instability.
Floating Rate Exposure Through Private Credit
This year, there has been a meaningful reset in bond markets as investors have rapidly exited low-yielding fixed income instruments. Inflation bites nothing harder than a fixed income security with interest payments that don’t adjust with rising price levels. Add in expectations for an aggressive monetary tightening from the Federal Reserve, and traditional fixed income markets have been one of the worst-performing asset classes this year.
While it is up for debate as to whether rising prices and tighter monetary policy may tip the U.S. economy into recession, there is no question that the rapid pace of GDP growth following the pandemic is one of the most significant contributors to the inflationary pressures. Therefore, it is not surprising that while rates have risen rapidly year-to-date, credit spreads have not meaningfully widened. In such an environment, investors can protect against the risk in traditional fixed income instruments with exposure to floating-rate loans.
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For investors seeking income without the risk of traditional exposures, some strategies can offer an excellent hedge to inflationary pressures as fixed income rates rise.
Commodities represent a solid opportunity to mitigate inflation risk.
Commodities typically go up alongside inflation, making them appealing when the prices of goods and raw materials are up. Few assets can benefit from a rise in prices, but commodities typically do.
The commodities market may become increasingly volatile as fighting continues in Eastern Europe. And while commodities are traditionally a haven from inflationary pressure, the war in Ukraine may present complicating factors to this kind of investment.
Outpacing Inflation Rates With REITs
REITs may give investors an edge over inflation, especially in regions with overheated housing markets. The Tax Reform Act of 1986 opened the door to the modern era of REITs allowing all American investors to take advantage of this structure. The changes in the late ’80s also gave REITs the legal authority “to operate and manage real estate, rather than simply owning or financing it”—thus allowing REITs to increase their revenue.
Today, REITs must pass on 90% of their taxable income to shareholders via dividends. Those payments have typically outpaced inflation (as measured by the Consumer Price Index), doing so in all but two of the last 20 years.
REITs tend to perform well in inflationary environments because of their ability to generate additional revenue through higher rents. The taxable income generated from rent is passed onto shareholders and can provide a valuable inflation hedge. However, investors must balance the effects of higher interest rates when considering real estate investments, given the typically heavy debt burden that these structures rely on.
Tales From The Crypto
It would be remiss not to mention the rising popularity of cryptocurrency and digital assets. In an October note, JPMorgan noted that some investors are pulling money out of gold to put into bitcoin—potentially seeing it as a better hedge against inflation.
But not all digital assets are created equal, and while the potential is enticing, crypto does not have the long history of private credit, commodities and REITs.
Investing In Trying Times
The outlook for 2022 remains questionable given the geopolitical situation and rising inflation. Still, there are bright spots for investors as commodities, REITs and private credit can provide safer havens during tumultuous times.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.