Risk Factors and Wine Hedge Against Inflation

After years of implementing permissive fiscal policies and injecting more money into the system, inflation has become a concern, and it may pose a significant challenge for investors. Indeed, witnessing the devaluation of assets due to unexpected spikes in inflation can be a painful experience. This month's reading¹ delves into the 'best strategies' for hedging against inflation.

The paper presents an empirical study that illustrates how different asset classes react during periods of inflation. While some concepts are likely familiar, such as the decline of bonds during inflationary periods, there are subtleties worthy of investigation. It highlights a dual behaviour of equities, which tend to rise with inflation - when it increases from a deflationary warning level - but ultimately decline when inflation surpasses a median threshold. Nevertheless, exposure to risk factors appears to remain the most effective method of hedging equity portfolios against inflation in real terms, with the momentum factor leading the way at an average of 8% real return during the 8 inflation regimes flagged in the US. Equity factors seem to avoid the substantial negative returns experienced by passive equity and fixed income strategies. On the other hand, it seems that there is no proxy to exhibit positive real returns during inflation shocks through sector allocation.  

For those with a passion for art, wine (before it has been drunk) and stamps, these assets also continue to serve as hedges against inflation, and this is surely a sufficiently fair excuse to hold them.

¹Neville, H., Draaisma, T., Funnell, B., Harvey, C. R., & Van Hemert, O. (2021). The best Strategies for inflationary Times. Social Science Research Network. https://doi.org/10.2139/ssrn.3813202
 

Benoit Lahaye
Junior Investment Analyst

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