Combatting Persistent Inflation: The Power of Real Assets

To beat the problem, investors may want to get into real assets.

Real assets including infrastructure, real estate and natural resources have long been wonderful inflation fighters. This includes periods of time such as today when inflation has been both stubborn and sticky. For investors, adding a dose of real assets to their portfolios could do wonders to fight inflation and generate real returns.

The Federal Reserve has done a wonderful job of getting inflation down from its peaks. The post-pandemic economy created a strange supply-demand dynamic coupled with plenty of extra stimulus measures, CPI has drifted lower from a peak of 9.1% — thanks to the Fed’s interest rate hiking.

The problem is, that inflation has stalled over the last few quarters.

A strong labor market, business trends and high consumer spending have continued to create a weird supply-demand dynamic. That dynamic has managed to keep prices high — despite the Fed’s tinkering on interest rates. According to the latest release from the Bureau of Labor Statistics, the current U.S. inflation rate is 3.4% for the 12-month period leading up to April 2024. That’s about 0.3% higher than the previous month’s reading. The Fed’s favorite measure of inflation — the personal consumption expenditures (PCE) price index, which kicks out food and energy costs — also increased 0.2% in April.

Both metrics are well above the Fed’s 2% inflation target and have stayed steady since last summer, and both are also well above the long-term average reading of inflation in the United States.

For investors, this has created a real issue. The high inflation environment will most likely prevent the Fed from cutting rates any time soon. In fact, there has been a growing call for the central bank to raise them. This creates recessionary risk. Meanwhile, high rates tend to crimp a variety of asset classes, including stocks and bonds. Higher rates mean higher borrowing costs, which hurt earnings, while bonds have an inverse relationship with interest rates.

The answer for investors who are dealing with this stubborn and persistent inflation could be to focus on so-called real assets.

Real assets are tangible assets that have value due to their substance and properties. Some examples of real assets include precious metals, commodities, real estate, infrastructure and other natural resources. Some asset managers also consider Treasury inflation-protected securities or TIPS bonds as a real asset given that they provide a return in excess of inflation.

The key is that these asset classes have long been able to beat measures of inflation. This chart from Principal shows real and nominal asset classes’ correlation to rolling inflation over periods of time. As you can see, real assets have been very correlated to CPI changes, providing good inflation hedging.

Source: Principal

The key for the inflation protection lies within how these real assets produce returns and income.

For example, infrastructure assets — which include things like pipelines, toll roads, bridges, and even solar farms — often include rate escalators that are tied to inflation. This means they can charge customers more when inflation rises.

Real estate is similar in that some sectors like hotels or self-storage assets feature short-term leases that can rise monthly or even daily to compensate for inflation. Meanwhile, other properties often include annual rate increases or riders that require tenants to pay for maintenance and taxes. This provides steady, rising cash flows during high inflationary periods.

Commodities and the stocks of natural resource producers are directly tied to underlying prices based on supply-demand. During periods of high inflation/high demand, the prices for corn, wheat, and oil, among other basic goods, rise. For the producers, these prices minus their costs equal cash flows/profits. The higher the price, the more they make.

These attributes have allowed real assets to be a great inflation-beating tool over the long haul. Looking at data, State Street has shown that a real asset portfolio has managed to outperform inflation over 3-yr, 5-yr and 10-year periods by roughly double during each of the time bands. This provides an attractive real — meaning after inflation — return for investors. Moreover, the asset manager’s research shows that adding real assets to a 60/40 stock/bond mix reduces volatility as well. ¹

For investors, the current stubborn inflationary environment is a wake-up call. We’re back to normal after years of low inflation in the post-Great Recession world — and that means inflation fighting is very much on the table. Real assets could be the answer.

Luckily, there are plenty of ways to do just that. Investors can run our screener here at Dividend.com for individual ideas. There are plenty of infrastructure, real estate and commodity producer names that can offer exposure to themes. For example, Simon Property Group, NextEra Energy and BHP Billiton could provide a one-two-three punch to all three sub-asset classes and a high dividend yield.

Another good choice? Go broad. The ETF explosion has created plenty of real asset funds that can be used to instantly add exposure to the entire concept of individual sub-asset classes. Here, investors don’t have to pick and choose. They can simply ramp up their exposure. With analysts suggesting that up to 20% of your portfolio be tied to these assets, an ETF makes short work of that.

These ETFs were selected based on their low-cost exposure to real assets and various sub-asset classes within the sector. They are sorted by their YTD total return, which ranges from -5% to 10.5%. They have expense ratios between 0.13% and 0.97% and assets under management between $4.8M and $64B. They are currently yielding between 0% and 4.8%.

Overall, inflation has continued to rise and then remain steady. This is a huge issue when it comes to the Federal Reserve and its ability to lower rates. For many asset classes and portfolios, that’s a huge negative. However, the way to overcome that could be by focusing on real assets. In the end, pipelines, real estate, and goods such as oil have the ability to generate real returns post-inflation and not suffer many of the negatives of other asset classes.

Inflation has been riding high for many quarters now. To fight that inflation, investors should get real. Real assets offer a host of benefits to fight inflation and have proven themselves over the long haul to generate strong returns in excess of inflation measures.

¹ State Street (December 2023). Liquid Real Assets: Cost-Effective Inflation Protection