protecting your portfolio from inflation...inflation and commodities– 3 alternative investment...
Post on 23-May-2020
3 Views
Preview:
TRANSCRIPT
Protecting Your Portfolio From
Inflation Keith Black, PhD, CFA, CAIA
Showcase your Knowledge @CAIA_Keith Black @CAIAAssociation
Inflation and Commodities– 2
About CAIA Association
The Global Leader in Alternative Investment Education
Non-profit established in 2002, based in Amherst, MA, with offices in Hong
Kong and London
Over 8,000 current charter holders in more than 80 countries
Over 24 vibrant chapters located in financial centers around the world
More than 120 educational and networking events each year
Offers AI education through the CAIA designation and the Fundamentals
of Alternatives certificate program
Inflation and Commodities– 3
Alternative Investment Education
Alternatives currently represent over $12 trillion in assets under management
and assets in liquid alternatives continue to rise.
The CAIA Association Mission:
Establish the CAIA designation as the benchmark for alternative
investment education worldwide
Promote professional development through continuing education,
innovative research and thought leadership
Advocate high standards of professional ethics
Connect industry professionals globally
Inflation and Commodities– 4
The CAIA Charter Designation
Globally recognized credential for professionals managing, analyzing,
distributing, or regulating alternative investments.
Highest standard of achievement in alternative investment education.
Comprehensive program comprised of a two-tier exam process:
Level I assesses understanding of various alternative asset classes
and knowledge of the tools and techniques used to evaluate the
risk-return attributes of each one.
Level II assesses application of the knowledge and analytics
learned in Level I within a portfolio management context.
Both levels include segments on ethics and professional
conduct.
Inflation and Commodities– 5
Fundamentals of Alternative Investments
The Fundamentals of Alternative Investments Certificate Program is a course
that provides a foundation of core concepts in alternative investments.
Fills a critical education gap for those who need to understand the evolving
landscape of alternative investments.
Online, 20-hour, self-paced course
Earns CE hours for the CIMA®, CIMC®, CPWA®, CFP® designations
Understand the core concepts in alternative investments
Gain confidence in discussing and positioning alternatives
Inflation and Commodities– 6
CAIA Curriculum
Level I
Chapter 10: Natural Resources and
Land
Chapter 12: Commodities: Applications
and Evidence
Level II
Chapter 3: Risk Management for
Endowment and Foundation Portfolios
Chapter 24: Role of Commodities in
Asset Allocation
Chapter 27: Macroeconomic
Determinants of Commodity Futures
Returns
Inflation and Commodities– 7
Why Hedge Inflation?
Most investors think in terms of nominal returns, especially in
the fixed income markets
However, rising inflation makes it more difficult to meet
terminal wealth goals in nominal terms
Investors with a greater need for inflation protection will
choose larger allocations to real assets
Endowments and foundations who seek to maintain
real spending while preserving the real value of the
endowment
Pensions who offer cost-of-living (COLA) adjustments
to their retirees
Corporations or individuals with fixed incomes, but
expenses that grow with inflation
Inflation and Commodities– 8
Inflation Uncertainty
With global fiscal and monetary stimulus, the uncertainty of future inflation is
high
While money supply growth is high, significantly higher inflation is unlikely to
come until employment and production levels increase
8 Source: Barclays
Inflation and Commodities– 9
Hedging Inflation
USCPI, 2015
Housing
33.2%
Medical and
Education
11.6%
Food and Energy
20.8%
Other Goods and
Services
34.4%
US Consumer Price Index, January 2016
Inflation and Commodities– 10
Inflation Betas
Where can institutional investors turn to hedge their inflation risk?
Studies have found that a few assets can hedge inflation risk (positive inflation beta), while the majority of institutional assets have a risk to rising inflation (negative inflation beta)
Within equities, smaller cap stocks and less capital intensive sectors have even greater inflation risk
In practice, many institutions build a real assets allocation, investing 5% to 20% of the portfolio in timberland, farmland, linkers and commodity futures
Assets with superior inflation protection may have lower risk-adjusted returns
20 Year US Treasuries
S&P 500 3 Month T-bills
10 Year TIPS
Farmland Commodity Futures
-3.1 -2.4 0.3 0.8 1.7 6.5
Bernstein Global Wealth Mgmt, “Deflating Inflation: Redefining the Inflation-Resistant Portfolio”, 2010
Inflation and Commodities– 11
Inflation-Linked Bonds
Sovereign debt issues offer a real yield with
an inflation-adjusted principal value
10 year US TIPS offer a real yield of
less than 0.4%
Break-even yield implies 1.55% future inflation, down from
2.5% last year
Bernstein estimates an inflation
beta of 0.8
Holding non-USD issues can hedge the
declining value of the dollar, but are more
sensitive to local country inflation
$2.3 trillion issued worldwide
Approximately 30% in US, 40% in UK
and Eurozone
30% in Canada, Australia, Japan,
Sweden, Iceland, Emerging Markets
Bernstein Global Wealth Management, “Deflating Inflation: Redefining the Inflation-Resistant Portfolio”, 2010 Barclays, “The Global Inflation-Linked Monthly Reflation and the Front End”, November 2015 11
Inflation and Commodities– 12
Equities
Equities have high long-term returns, but suffer in the short run from higher
interest rates during times of inflation
Firms in the natural resource, energy and real estate sectors have greater
inflation protection than broad equity indices
Energy and metals stocks have an inflation beta of 2, REITs of -2, and
S&P 500 of -2.4
Smaller stocks and less capital intensive stocks get hurt the most by rising
inflation
Rising Inflation Leaders to Higher Earnings… … but a Higher Discount Rate Hurts Valuations
Bernstein Global Wealth Mgmt, “Deflating Inflation: Redefining the Inflation-Resistant Portfolio”, 2010
Inflation and Commodities– 13
Real Estate and REITs
Real estate investments are a hybrid between fixed income
and equity securities, with inflation hedging potential
depending on property income and debt structure
Long-term leases are similar to fixed income instruments,
as fixed rate leases suffer from higher discount rates
Property equity can act like stocks, rising with long-term
inflation
Inflation and Commodities– 14
Timberland
Like real estate, the land value can be negatively affected by
inflation
Like commodities, timber values are positively affected by
inflation
Can be correlated to economic activity, especially housing
starts
Interesting real options characteristics, where waiting to
harvest during times of low prices can lead to another year of
biological growth
Martin, “The Long-Horizon Benefits of Traditional and New Real Assets in the Institutional Portfolio”, Journal of Alternative Investments, 2010
Inflation and Commodities– 15
Farmland
Unlike infrastructure or real estate, the supply of farmland is
fixed or shrinking despite growing demand for food
Returns may be leveraged to growth in population and
income in emerging markets
Commodity-based rents benefit from short-term inflation
Bernstein estimates an inflation beta of 1.7
Permanent crops, such as orchards or citrus, have different
characteristics than row crops
Row crops, such as corn or wheat, have annual option to
switch to a more profitable crop
Bernstein Global Wealth Mgmt, “Deflating Inflation: Redefining the Inflation-Resistant Portfolio”, 2010
Inflation and Commodities– 16
Infrastructure and MLPs
Toll roads, pipelines, ports and utilities can benefit from
inflation when user fees increase at a greater rate than
expenses
Infrastructure is a hybrid asset class, having characteristics
of fixed income, real estate and private equity
Many infrastructure assets have low price elasticity of
demand, making the cash flows somewhat recession
proof
Some contracts to operate regulated assets include
inflation escalation clauses
Investment opportunities may be large due to growing
energy demand, governmental budget deficits and
needs for infrastructure growth and rehabilitation
Inflation and Commodities– 18
Commodity Futures Indices
Energy
63%
Industrial
Metals
9%
Precious
Metals
3%
Grains,
Meats, Softs
24%
S&P GSCI Commodity Index, 2016 Weights
Energy
31%
Industrial
Metals
17%
Precious
Metals
16%
Grains,
Meats, Softs
36%
Bloomberg Commodity Index, 2016 Target Weights
S&P GSCI, 2016 Bloomberg, 2016
Inflation and Commodities– 19
Diversification Potential of Commodities
* Total Return Indices include the return of 91-day Treasury Bill yield.
** Includes reinvestment of dividends and interests. CISDM Indices are net of manager fees.
Commodity Index Performance
20-Year History (through December 2014)
Commodity Index
Performance S&P GSCI Bloomberg
Annualized Total Return* 4.6% 4.5%
Annualized Std. Dev. 22.1% 15.8%
Sharpe Ratio 0.07 0.09
Maximum Drawdown -70.9% -59.8%
Correlation with S&P GSCI 1 0.90
Correlation with Bloomberg 0.90 1
U.S. and Global Stock
and Bond Index Barclays Capital MSCI JPM Credit Suisse Credit Suisse
Performance S&P 500 U.S. Bond World Equity Global Bond HFI Managed Futures HF
Annualized Total Return** 10.6% 6.1% 8.0% 5.8% 9.0% 5.8%
Annualized Standard Deviation 15.1% 3.5% 15.2% 5.8% 7.1% 11.7%
Sharpe Ratio 0.50 0.86 0.33 0.48 0.84 0.24
Maximum Drawdown -56.5% -5.8% -56.0% -12.3% -22.8% -23.9%
Correlation with S&P GSCI 0.25 0.01 0.34 0.20 0.38 0.15
Correlation with Bloomberg 0.33 0.06 0.42 0.29 0.42 0.22
Inflation and Commodities– 20
Attractive Correlation Characteristics
Commodity futures returns have attractive correlation
characteristics over long time periods
Gorton/Rouwenhorst, “Facts and Fantasies about Commodity Futures Ten Years Later”, 2015
Stocks Bonds Inflation
1 Year 0.04 -0.25 0.24
5 Years -0.26 -0.25 0.47
Inflation and Commodities– 21
Trends in Correlation
Bhardwaj/Gorton/Rouwenhorst, “Facts and Fantasies about Commodity Futures Ten Years Later”, 2015
Inflation and Commodities– 23
Hedging Inflation
-0.50
-0.40
-0.30
-0.20
-0.10
0.00
0.10
0.20
0.30
0.40
0.50
0.60
Jan
-94
Jun
-94
No
v-9
4
Ap
r-9
5
Sep
-95
Feb
-96
Jul-
96
De
c-9
6
May
-97
Oct
-97
Mar
-98
Au
g-9
8
Jan
-99
Jun
-99
No
v-9
9
Ap
r-0
0
Sep
-00
Feb
-01
Jul-
01
De
c-0
1
May
-02
Oct
-02
Mar
-03
Au
g-0
3
Jan
-04
Jun
-04
No
v-0
4
Ap
r-0
5
Sep
-05
Feb
-06
Jul-
06
De
c-0
6
May
-07
Oct
-07
Mar
-08
Au
g-0
8
Jan
-09
Jun
-09
No
v-0
9
Ap
r-1
0
Sep
-10
Feb
-11
Jul-
11
De
c-1
1
May
-12
Oct
-12
Mar
-13
Au
g-1
3
Jan
-14
Jun
-14
No
v-1
4
36 Month Rolling Correlation to Inflation Stocks vs. Commodities
S&P 500, CPI Bloomberg Commodity Index , CPI
S&P 500, Bloomberg, 2014
Inflation and Commodities– 24
Timing Commodity Investments
X. Kang, “Commodity Investments: The Missing Piece of the Portfolio Puzzle?”, S&P Dow Jones Indices, 2012 24
Inflation and Commodities– 25
Supply Constraints
Commodities with supply constraints can have higher volatility and greater
upside potential
Energy and Industrial Metals (Volatility of 32% and 21%)
These commodities have the greatest supply constraints, as production is
subject to location, mining/drilling, refining and environmental issues
Agriculture (Volatility of 18%)
Supply shortages tend to be short lived, as next year’s growing/breeding
season may overcome this year’s shortages
Precious Metals (Volatility of 16%)
Supply has little impact, as metals are held for centuries as a store of value
and little is consumed
Inflation and Commodities– 26
The Role of Emerging Markets
The prices of many commodities are tied to the demand from Asian
emerging markets
India and China are rapidly gentrifying nations with over 2.5 billion of the
world’s 6.8 billion citizens
This consumption relative to world demand is falling. Consumption of
cement, steel, aluminum, coal and copper grew by over 10% annually
from 2006 to 2011, but growth has slowed in recent years
Chinese Commodity Consumption as a Portion of World Demand
Cement2 Soybeans1 Coal3 Copper1 Iron Ore1 Aluminum4
55% 66% 50% 44% 66% 45%
1) Wall Street Journal, 2013 2) Societe Generale, 2010 3) Energy Trends Inside, 2012 4) Morgan Stanley, 2012
Inflation and Commodities– 32
Reasons for Selloff: Demand
32
Falling commodity prices closely related to declines in
emerging markets, from GDP and industrial production to
currency and equity prices
Inflation and Commodities– 33
Reasons for Selloff? USD Strength
33
USD commodity prices falling much faster than when purchased using weak Euro or emerging market currencies Weak EM currencies encourage local producers to increase exports
Inflation and Commodities– 34
CAIA Curriculum
Level I
Chapter 10: Natural Resources and
Land
Chapter 12: Commodities: Applications
and Evidence
Level II
Chapter 3: Risk Management for
Endowment and Foundation Portfolios
Chapter 24: Role of Commodities in
Asset Allocation
Chapter 27: Macroeconomic
Determinants of Commodity Futures
Returns
top related