ITo protect against inflation, nvestors may use exchange traded funds.
The webcast was recorded on the latest episode. Inflation: Preparing Portfolios for a Shifting EnvironmentBrian Griggs (Managing Director, Portfolio Strategist, Nuveen) explains that investors must adapt to a new norm as the Federal Reserve raises interest rates for first time since December 2018. Inflation continues to rise while unemployment rates are still falling. The policy path is still uncertain because of the conflict in Ukraine and its resulting energy price shock.
Griggs also noted that we may be in uncharted territory. Investors can’t use the rising rates in the 1970s to guide them, since they are diverging in terms of inflation and unemployment.
Griggs believes that although the Fed’s hawkish pivot may have already had an effect on long-term inflation anticipations, the pace at which tightening is implemented will be crucial in determining how quickly inflation moderates. In other words, it is important not to react excessively to higher inflation.
Even if inflation slows down, it will still have investment implications. Griggs predicts that traditional allocations could face a decline in inflation if there is a higher average inflation. Griggs also asserts that although inflation may slow down, it should still be higher on average than in the last decade.
The traditional 60/40 portfolio is already feeling the strain in such an environment. U.S. bonds are also underperforming. Griggs warns asset managers that traditional fixed income doesn’t provide the usual price return buffer.
Griggs declares, “It is time to reinvent the portfolio playbook.”
Griggs believes investors should prepare for runaway inflation if inflationary pressures rise above the average norm. A high inflation environment is not a new phenomenon for the U.S. Economy. Inflation has increased by 40% in quarters over the five-year average since 1988. Public REITs, U.S. large cap core, U.S-small-cap and emerging market equity are the best performing asset categories in this high-inflationary environment.
Investors are looking for ways to adapt their investment portfolios to an increased inflationary environment. Alex Graf, ETF specialist and Nuveen’s ESG model and institutional analyst, suggests that they stick to quality, undervalued opportunities, and dividends in equity markets. To limit rising interest rates and duration risk, investors should look for short-duration bonds. He also believes that investors may be able to find opportunities in short-term real property investment trusts.
Graf recommends ETFs like this to investors to gain exposure to these strategies. Nuveen ESG Large Cap Value ETF (BATS NULV)TheNuveen ESG Mid Cap Value ETF (NUMV),The Nuveen ESG Dividend ETF – Cboe: NUDVThe Nuveen Enhanced Yield 1-5 year U.S. Aggregate Bond ETF (NYSEArca : NUSA)., andNuShares Short-Term ETF (BATS : NURE)..
Nuveen’s money managers also use ESG criteria to target socially responsible companies. Nuveen uses an ESG rating to determine an issuer’s performance relative to peers. It also captures a controversy score that captures issuers response to events-driven controversies. A controversial business investment component that captures issuers involvement in industries that may cause serious social harm and low-carbon criteria which captures the issuer’s carbon intensity based on their involvement in specific industries.
The ESG factors can be divided into three broad categories. The environmental factor refers to climate change and greenhouse gas emissions, as well as resource depletion (including waste, pollution, and water). The social aspect includes working conditions including child labor, community or indigenous populations, operations into conflict zones, health, safety, employee relationships, and diversity. Finally, the governance factor considers executive pay, corruption, political lobbying and contributions, board diversity and structure, tax structure, and board diversity.
NUSA tries reflect the performance of BofA Merrill Lynch’s Enhanced Yield 1-5 year US Broad Bond Index. It is represented by a modified version, the BofA Merrill Lynch 1-5 year US Broad Market Index.
The Enhanced Index does away with market capitalization and instead assigns components to various categories based on asset type, sector, credit quality, maturity, or both. Smart beta indexing is a rules-based method that assigns higher weights and yields to categories while still maintaining credit quality, risk, and risk similar to the Base Index.
NURE also tries to reflect the Dow Jones U.S. performance. Select Short-Term REIT Index is a group of real estate investment trusts that invest only in residential or commercial real property with a shorter lease term than other REITs.
NURE focuses primarily on REITs with short term lease agreements. These may be less volatile and more sensitive to interest-rate fluctuations than longer-term REITs. These short-term REITs can be a good way to generate income in a rising rate environment. Short-term contracts allow businesses the flexibility to adjust to market changes and reprice their investments accordingly. Businesses’ prudent responses could result in higher returns for investors due to the REITs structure. This allows most revenue to be distributed to shareholders as income.
In addition, the short-term REIT sector has shown better risk/return characteristics than the wider REIT market. They showed higher returns over all time periods, with lower volatility over longer term. Additionally, the short-term segment had a similar dividend profile over a 5-year average, despite recent declines.
Financial advisors interested in learning more on investment portfolio strategies can contact us. You can watch the webcast on demand here.
These views and opinions are solely the author’s and do not necessarily reflect the views of Nasdaq, Inc.
