Dude, Where’s My Real Assets Exposure?
February 14, 2023
Read Time 3 MIN
We have the opportunity to speak with a lot of investors and one question keeps coming up: Should I avoid real assets exposure because inflation is falling?
Our short answer is NO! That would be akin to cancelling your flood insurance during a hurricane. High inflation is not as rare as you think, and investors should always maintain a strategic allocation to inflation-fighting assets. High inflation events have occurred 30% of the time and, once they begin, have taken on average 18 years to resolve.
A thoughtful asset allocation framework should be designed to perform in each of the four major economic regimes. The chart below illustrates how frequently the different economic regimes have occurred.
Frequency of Historical Economic Regimes Shows High Inflation Is Not That Rare
Historical Economic Regimes
Source: Bloomberg. GDP scenarios from March 31, 1948 through February 7, 2023. Inflation scenarios from January 31, 2014 to February 7, 2023. Past performance is no guarantee of future results.
The 2010s were hallmarked by low growth and low inflation. As a result, many investors are now conditioned to believe that we will remain in this regime and that any deviation from this path must only be temporary. This is why many investors are not properly allocated for the current environment. Compounding this problem, most investors see slowing inflation as a reason to not protect themselves going forward.
“Growth is dead!” said the value portfolio manager in 2007 and “Value is dead!” said the growth portfolio manager in 2020. This reflects how extended economic regimes condition the expectations of investors and only leaves them fighting the last war. Economic cycles change, and the investments that are needed to be successful in those regimes change along with them.
Let’s look at two well-known stocks as an example of how a changing macroeconomic environment can impact performance: Microsoft (MSFT) and Exxon Mobile (XOM).
Buy MSFT and go on vacation. This would have been an effective strategy in the previous regime. During the decade ending in 2021, MSFT returned 1,437%, the S&P 500 Index returned 340% and XOM returned 8%. Will this continue into the future? Unlikely.
MSFT is a classic growth stock that was well positioned to perform in a low growth/low inflation environment and XOM is a classic value stock that benefits from higher commodity prices associated with elevated inflation.
The chart below illustrates the free cash flow (FCF) yields, or the relationship between operating performance and forward one-year performance. A positive black line corresponds to periods when XOM’s FCF yield is higher than MSFT’s FCF yield and vice versa. The blue and gray areas reflect the forward one-year performance for XOM and MSFT, respectfully.
XOM and MSFT FCF Yields Linked to Performance Across Economic Regimes
Free Cash Flow Yield & Forward Rolling Return
Source: Bloomberg as of 6/30/2022. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities referenced herein.
Three takeaways from this chart are:
- High relative FCF yields have been associated with strong performance. XOM outperformed MSFT by 10.6%, annually, on average, when XOM had higher FCF yields.
- The trends in FCF yields and outperformance correspond to the different economic regimes and typically last for extended periods of time.
- The current FCF yields and recent performance of XOM are significantly higher than MSFT and this trend may continue.
MSFT and XOM are two examples of how the relative attractiveness of investments change in different economic environments. We are currently in a high inflation regime and the threat of an extended period of high inflation is very real. Investors would be wise to proceed with caution and diversify across stocks, bonds and REAL ASSETS. Our inflation analysis suggests that a portfolio of stocks and bonds with a dedicated allocation of 15% to a diversified basket of inflation fighting assets may provide the balance needed to perform in each economic regime.
Our preferred investment solution is the VanEck Inflation Allocation ETF (RAAX) because it provides exposure to the key, time-tested inflation hedges in a risk controlled framework that adapts to changing economic regimes.
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DISCLOSURES
This is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results. Information provided by third–party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. Any opinions, projections, forecasts, and forward–looking statements presented herein are valid as of the date of this communication and are subject to change without notice. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its employees.
S&P 500 Index is widely regarded as the best single gauge of large–cap U.S. equities. The index is a float–adjusted, market–cap–weighted index of 500 leading U.S. companies from across all market sectors including information technology, telecommunications services, utilities, energy, materials, industrials, real estate, financials, health care, consumer discretionary, and consumer staples.
The S&P 500 Index is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Van Eck Associates Corporation. Copyright © 2023 S&P Dow Jones Indices LLC, a division of S&P Global, Inc., and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indices LLC’s indices please visit www.spglobal.com/spdji/en/. S&P® is a registered trademark of S&P Global and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein.
VanEck Inflation Allocation ETF (RAAX): An investment in the Fund may be subject to risks which include, among others, risks related to investing in real assets ETPs, which may subject the Fund to commodities, gold, natural resources companies, MLPs, real estate sector, infrastructure, ETP-related equity securities, small- and medium-capitalization companies, foreign securities, emerging market issuers, ETP-related foreign currency, credit, interest rate, call, concentration and derivative risks, all of which may adversely affect the Fund. The Fund may also be subject to fund of funds, affiliated fund, U.S. Treasury Bills, subsidiary investment, commodity regulatory (with respect to investments in the Subsidiary), tax (with respect to investments in the Subsidiary), cryptocurrency, cryptocurrency tax, liquidity (with respect to commodities instruments), gap, cash transactions, high portfolio turnover, models and data, active management, operational, authorized participant concentration, no guarantee of active trading market, trading issues, market, fund shares trading, premium/discount and liquidity of fund shares, and non-diversified risks. Foreign investments are subject to risks, which include changes in economic and political conditions, foreign currency fluctuations, changes in foreign regulations, and changes in currency exchange rates which may negatively impact the Fund's returns. Small- and medium-capitalization companies may be subject to elevated risks.
Investing involves substantial risk and high volatility, including possible loss of principal. An investor should consider the investment objective, risks, charges and expenses of the Fund carefully before investing. To obtain a prospectus and summary prospectus, which contains this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.
©️ 2023 Van Eck Securities Corporation, Distributor, a wholly owned subsidiary of Van Eck Associates Corporation.
Related Funds
DISCLOSURES
This is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results. Information provided by third–party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. Any opinions, projections, forecasts, and forward–looking statements presented herein are valid as of the date of this communication and are subject to change without notice. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its employees.
S&P 500 Index is widely regarded as the best single gauge of large–cap U.S. equities. The index is a float–adjusted, market–cap–weighted index of 500 leading U.S. companies from across all market sectors including information technology, telecommunications services, utilities, energy, materials, industrials, real estate, financials, health care, consumer discretionary, and consumer staples.
The S&P 500 Index is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Van Eck Associates Corporation. Copyright © 2023 S&P Dow Jones Indices LLC, a division of S&P Global, Inc., and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indices LLC’s indices please visit www.spglobal.com/spdji/en/. S&P® is a registered trademark of S&P Global and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein.
VanEck Inflation Allocation ETF (RAAX): An investment in the Fund may be subject to risks which include, among others, risks related to investing in real assets ETPs, which may subject the Fund to commodities, gold, natural resources companies, MLPs, real estate sector, infrastructure, ETP-related equity securities, small- and medium-capitalization companies, foreign securities, emerging market issuers, ETP-related foreign currency, credit, interest rate, call, concentration and derivative risks, all of which may adversely affect the Fund. The Fund may also be subject to fund of funds, affiliated fund, U.S. Treasury Bills, subsidiary investment, commodity regulatory (with respect to investments in the Subsidiary), tax (with respect to investments in the Subsidiary), cryptocurrency, cryptocurrency tax, liquidity (with respect to commodities instruments), gap, cash transactions, high portfolio turnover, models and data, active management, operational, authorized participant concentration, no guarantee of active trading market, trading issues, market, fund shares trading, premium/discount and liquidity of fund shares, and non-diversified risks. Foreign investments are subject to risks, which include changes in economic and political conditions, foreign currency fluctuations, changes in foreign regulations, and changes in currency exchange rates which may negatively impact the Fund's returns. Small- and medium-capitalization companies may be subject to elevated risks.
Investing involves substantial risk and high volatility, including possible loss of principal. An investor should consider the investment objective, risks, charges and expenses of the Fund carefully before investing. To obtain a prospectus and summary prospectus, which contains this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.
©️ 2023 Van Eck Securities Corporation, Distributor, a wholly owned subsidiary of Van Eck Associates Corporation.