Morningstar's US-based director of personal finance, Christine Benz, recently spoke about which asset classes may help retirees hedge against inflation.

This segment can be particularly vulnerable to inflation, as they have a lot of areas of their spending--like healthcare, property taxes, long-term care--going up faster than general prices. This demographic also tends to have more conservative portfolios. 

Which investor segments are most vulnerable?

"You want to think about two key things…where you are getting your in-retirement cash flows. Say, you are lucky enough to have a pension that is inflation-adjusted and is supplying most of your cash-flow needs in retirement--you are a person who has to worry less about inflation as it relates to your portfolio. 

"On the flip side [is someone] drawing actively from their portfolio--you don't have a lot of inflation-adjusted income streams that you are bringing into retirement, and your portfolio happens to be somewhat conservative.

"So, you have a lot of fixed-rate investments--whether bonds or cash investments--you are a person who needs to look at that portfolio and think about, 'what can I do with this portfolio to give it a little bit of inflation protection?'"

Stocks

More traditionally, equities have been regarded as something of an inflation hedge. According to Benz, this has been the case historically, with stocks "having the best long-run shot at out-earning inflation, particularly over long periods of time".

However, she emphasises they are not a direct hedge against inflation on a year-by-year basis.

"In a year in which inflation is going up, there is no guarantee that stocks will also go up that year.

"But nonetheless, the fact that stocks can out-earn inflation over time, out-gain inflation is the key reason why, whenever I put together model portfolios, I typically recommend equity allocations of at least 50 per cent, simply because retirees need that growth potential in their portfolios," she says.

Fixed income

Benz also refers to Treasury Inflation-Protected Securities--which in Australia, are better known as inflation-linked government bonds. "Over time…they have been a pretty good bet if you are looking for something in your portfolio that will hedge against inflation."

As one of the most direct ways to protect against the effects of inflation, she believes they are a good addition to retiree tool kits.

"The key thing that retirees have to keep their eyes on--and this is something that's bubbled up very recently--is that they tend to be pretty interest-rate sensitive, and that's only logical because when inflation worries are running high, that's often when we are seeing interest rates popping up.

"That's one reason why I tend to like the shorter-term inflation-protected government bond products, because they deliver that inflation protection without a lot of interest-rate related noise," Benz says.

Property

Real estate exposure is another area retiree investors may also consider in this context. "In part because typically, as inflation has been rising, we also see higher rents coming online.

"As a [real estate investment trust] REIT owner, even an owner of residential real estate, you benefit even as you are having to pay higher prices for other things to go about your business," Benz says.

"On the flip side though…REITs tend to be pretty interest-rate sensitive, and that's something we have seen on display very recently, too, whereas higher yields have been coming online, people have been saying, 'Well, why do I want this volatile REIT asset when I could own government bonds or other bonds that are coming to market with higher yields?'" According to Benz, this is a trade-off that real estate investors face.

Commodities?

Among commodities, precious metals and resources like oil are also often considered by retirees who are seeking to gird their portfolio against high inflation.

"A lot of academics have looked at this over the years--even though [precious metals] have been held out as a good hedge against inflation, in general, I don't think so.

"Another thing that you need to keep in mind is that precious metals tend to be extraordinarily volatile. They can be difficult for individual investors to own, whether a precious metals fund or other precious metals investments. I typically don't recommend them as standalone holdings in retiree portfolios," Benz says.

She also downplays the potential role of oil futures as inflation hedges. "Certainly, there was a lot of enthusiasm for commodities as an inflation hedge a decade ago. A decade later, we have seen a lot of the commodities-tracking investments, which use futures to obtain commodities exposure, really suffered due to this negative roll yield problem.

"You've had a disconnect between commodities prices and the returns that people investing in these products have pocketed. I don't see this category as a must-have for people who are worried about inflation."

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Based in Chicago, Jeremy Glaser is senior director of individual investor editorial for Morningstar.

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