Alessio de Longis is a vice president at Oppenheimer and a manager on the Oppenheimer Currency Opportunities Fund.
Jason Stipp: Alessio, I want to turn the conversation a bit and talk about some of the tools that investors may look to keep ahead of inflation.
You folks at Oppenheimer have taken a look at the role of currencies in fighting inflation. A couple of questions on that front; the first is, obviously this has to do with the worries about the decline of the U.S. dollar, depreciation of the U.S. dollar, and what role that will play in the inflationary environment. Secondly, how do you think about the dynamics of currency as you're looking to take currency positions because we might see the U.S. dollar declining, but we also know that foreign countries have been somewhat reluctant to let their currencies appreciate because they still want to have competitive exports?
Alessio de Longis: Absolutely. The dollar plays a major role in the inflation story for the United States. Dollar depreciation is a major cause and a key driver of the rise in import price inflation. The economics are very simple. As the dollar loses value, we need to spend more dollars and pay higher prices to import the foreign goods that we consume every day.
Let me give you a couple of statistics. Over the last year alone, as we mentioned, import price inflation has been rising at about 13.5%, and the dollar has depreciated against a basket of currencies of our largest trading partners for about 10%. Those are the countries ... the depreciation of the dollar against the countries that we import most from is what matters with respect to the relationship to import price inflation.
And this is just not a near-term phenomenon. Over the last 10 years, the dynamics, the depreciation of the dollar against these large set of currencies of our major trading partners has had a correlation of more than 60% with the import price index.
So, you can clearly see how, over the last year alone for example, 10% depreciation versus 13.5% import price inflation, you can see how owning foreign currencies in your portfolio would have served as a very effective hedge against this type of inflation, against imported inflation.
Stipp: So, when you're looking at currency positions, how do you decide which currencies have the best potential, and when you're looking at that diversification, that basket that you mentioned, how do you take those positions? How do you know what's going to be the most attractive currencies?
de Longis: Yes, as I described, because of the rationale that we just talked about, we believe that once an investor has decided a currency allocation in his portfolio, a core of that currency allocation should always be dedicated to our largest trading partners for the inflation hedge reasons we just described. So, that would argue for always large positions in currencies of countries such as Mexico, Canada, the Eurozone, Japan, but also China.
Now, China is an interesting case. We import a lot from China, but as you just described, Chinese authorities are very aggressive in preventing their currencies from appreciating. How do we resolve that problem?
We like to proxy the exposure to China through other currencies of countries that are particularly linked to the Chinese economy, whether it's through the manufacturing cycle or through the commodity cycle. Think about Australia, Brazil, Korea, Chile; these are all economies that are particularly linked to China.
Leaving the inflation hedge story aside, which is an important one, we like to also add value in additional currency positions, and given the current status of the world economy, we believe we're about to see a re-acceleration in global growth, and in that environment, we like to own currencies of high-yielding emerging markets, particularly those exposed to the commodity cycle.
Stipp: Alessio, those are great insights on currencies. I want to touch base with you on a few other inflation fighting tools--traditional inflation fighting tools--to get your take. TIPS, Treasury Inflation Protected Securities, are one area that investors looks to as they are hoping to keep ahead of inflation. What's your take on that asset class? We did see some real yields among TIPS go negative recently, which was a concern.
de Longis: Absolutely. We don't see TIPS as a very attractive inflation hedge, both from a tactical standpoint as well as structurally as an asset class. From a tactical standpoint, you are raising a very good point. Real interest rates are currently negative all the way out to seven-year maturities. Now, that creates a very vulnerable environment for TIPS as an asset class.
If you expect a simple rise of real interest rates back to normal levels of, say, 1% to 1.5%, which is absolutely normal by historical standards, a rise in real yields by about 100 basis points would create a very negative environment for the price of TIPS, for the price of those securities.
Most importantly, the reasons why inflationary pressures may build in the economy are the same reasons that may lead to a rise in real interest rates, which is, a re-acceleration in the U.S. economy. So, you may well try to protect against rising inflation and still be very disappointed in the total return of those securities because of the rise in real interest rates.
But leaving that aside, we are not that fond of TIPS as an inflation hedge from a structural point of view in the design of the asset class. TIPS are linked to the CPI. As we just described earlier, CPI are not necessarily the best measure of inflation that consumers need to hedge away against.
Stipp: Commodities and real estate are other areas that investors look to for inflation protection. What's your take on those asset classes?
de Longis: Commodities, real estate, all these are very important inflation hedge vehicles. ... When we look at all these measures of inflation or these potential inflation hedges, rather than spending too much time trying to assess the correlations and the valuations between these assets, we believe investors are better off by deciding an overall allocation to inflation in their portfolio, and within that allocation to inflation, to distribute their capital across many inflation hedges, such as gold, commodities, currencies, and real estate.
Now, the reason for that is because it's very difficult to time different inflationary sources in the economy, and therefore it's very difficult for the average investor to time the entry and exit in and out of these different asset classes. We believe investors should be allocating to inflation as an overall theme and maybe be more wary of the different volatilities between these asset classes.
If an asset, say, commodities, is about three to four times more volatile than currencies, then investors in structuring their portfolio should probably be aware of those volatilities and allocate proportionally less to more volatile assets and proportionally more to less volatile assets. In that way, the ultimate goal is to achieve an inflation package that is very stable and broad-based in nature, that offers you that reliable inflation hedge that you're looking for and diversified.
Stipp: Alessio de Longis, thanks so much for your input on inflation and ideas around portfolio planning to keep ahead of inflation, and for calling in today.
de Longis: Thank you very much, Jason.
Stipp: From Morningstar, I'm Jason Stipp. Thanks for watching.