Exchange traded funds can be used by investors to protect their portfolios against inflation risks.
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 path of policy is highly uncertain due to the ongoing war in Ukraine and the resulting shock from the energy price.
Griggs also notes that we may be in uncharted territory, as investors can’t really use the rising rates of the 1970s as a definitive guideline, since inflation and unemployment rates are trending in opposite directions.
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. Therefore, allocators shouldn’t react too strongly to higher inflation in the trailing period.
Even if inflation is lower, it will have investment implications. Griggs believes that a higher average inflation in the future could be a problem for traditional allocations. He also believes that inflation could moderate, but should remain higher than it was in the past decade.
The traditional 60/40 investment portfolio is already suffering from the stress of this environment. U.S. government bonds are underperforming in this environment. Griggs warns asset managers that traditional fixed income doesn’t provide the usual price return buffer.
“Its time to reinvent the portfolio playbook,” Griggs says.
Griggs believes investors should prepare for runaway inflation if inflationary pressures rise above the average norm. An elevated inflationary environment isn’t anything new 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 reduce rising interest rate risk and to reduce duration risk, investors should also consider short-duration bonds. He believes investors can also find opportunities in short term real estate 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 MidCap Value ETF (NUMV),The Nuveen ESG Dividend ETF – Cboe: NUDVThe Nuveen Enhanced Yield 1-5 year U.S. Aggregate Bond ETF (NYSEArca : NUSA)., and theNuShares Short Term ETF (BATS, NURE).
Nuveen’s money manager uses several other ESG criteria in order to better target companies with socially responsible characteristics. Nuveen applies an ESG Rating to capture an issuers performance relative to peers. This includes a controversy score which captures an issuers response and exposure to event-drivencontroversies. Low-carbon criteria captures an issuers carbon intensity based upon their involvement in particular industries.
The ESG factors are 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). Social refers to working conditions, including child labor, community, indigenous populations, operations within conflict zones, safety, health, employee relations, diversity. Finally, the governance factor considers executive pay, corruption, political lobbying and contributions, board diversity and structure, tax structure, and executive pay.
NUSA attempts to reflect the performance and the BofA Merrill Lynch US Broad Bond Index Enhanced Yield 1-5 Years US Broad Bond Index. This index is a modified version the more well-known BofA Merrill Lynch US Broad Market Index 1-5 Years 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 attempts to reflect the performance and trends of Dow Jones U.S. 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 on REITs that have short-term lease agreements. These REITs may be less volatile or more sensitive to interest rate changes than long-term REITs. These types of short-term REITs could be a good option for income-minded investors who want to access yield generation in a rising-rate environment. Because short-term lease agreements allow businesses to quickly adjust to changing market conditions and to reprice, these types of REITs may be a good choice. 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 in 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 about investment strategies can view the webcast on demand.
