Grading the Inflation Hedges

A version of this article was published in the June 2022 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor by visiting the website.

Last August, I wrote about various inflation hedges and their pros and cons. For a while there it looked like inflation would cool off, but a resurgent economy and Russia's invasion of Ukraine instead led to a more severe spike in prices that does not appear anywhere near fading. So, I thought I'd get you up to speed on how Morningstar Medalists in the various asset types I featured have done because it's been so long since we had a serious level of inflation. I'll focus on one-year returns ended May 2022. Just as a refresher, I mentioned direct hedges Treasury Inflation-Protected Securities and commodities. Indirect hedges were bank loans, equities, and gold. I also mentioned all-in-one inflation fighters from the allocation categories.

Vanguard Short-Term Inflation-Protected Securities Index VTAPX has a Morningstar Analyst Rating of Gold and an appealing 2.6% return for the past year, though it also has a less-appealing 0.1% gain so far in 2022. Yes, you get paid for a spike in inflation, but the direction of interest rates also affects TIPS and has undermined the good. Longer-term TIPS funds like Vanguard Inflation-Protected Securities VAIPX have been hit harder because of that interest-rate risk. That fund is down 5.7% year to date and 1.4% for the past 12 months.

Pimco Commodity Real Return Strategy PCRAX is the star of the show. It's up 42.3% for the year and 31.3% for 2022. It's a broad commodities strategy anchored by TIPS, but the TIPS part hasn't really mattered lately because oil and other commodities prices are surging. This Bronze-rated fund is one of the best commodities plays. It's not very tax-efficient, though, so it might be best in an IRA or 401(k).

Bank loans have lost less than most bonds, but they aren't stars. T. Rowe Price Floating Rate PRFRX is down 2.6% for the past 12 months and 0.5% year to date. Bank loans have ratcheted up their yields as they are supposed to. However, credit risks have been punished, and bank loans haven't held up as well as investors might have hoped.

For equities, the first couple of jumps in inflation didn't faze the market, but in 2022 it became clear that the Federal Reserve had many rate hikes in store and inflation was getting worse. That’s when stocks rolled over.

I've chosen a medalist each from the U.S. large-cap blend and foreign large-cap blend Morningstar Categories to illustrate. Silver-rated American Funds Fundamental Investors ANCFX shed 12.4% for the year to date and 4.9% for the past year. That's a touch better than the year-to-date losses of the big index funds but still shows that in the short run, equities are an unreliable inflation hedge. In theory, growth funds might be a big help because growth companies tend to have good pricing power. However, growth stocks have had such a big runup that they've been hit much harder than value.

For foreign funds, let's look at T. Rowe Price Overseas Stock TROSX, which is rated Silver. Its returns were close to those of the big index funds, and that's not pretty. It lost 10.6% year to date and 10.2% for the past year. The dollar has actually surged despite the rise in inflation, as inflation is a worldwide economic problem. The rising dollar just added to the pain of investors in foreign funds.

For precious metals, we don't have a fund in the Morningstar 500, so I'll just mention that the equity precious-metals category is off 5.5% for the year to date and 19.8% for the trailing year. Ugh. In the article, I had crypto currency in the "I have no idea" bucket, and it has been the biggest disappointment of all. The S&P Cryptocurrency Broad Digital Market Index is down 32% for the past year. Rather than protecting against inflation, crypto continues to act a lot like a high-risk tech stock.