Alternative Investments for Periods of Inflation

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Michael Sager

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Michael Sager, Executive Director of Multi-Asset and Currency at CIBC Asset Management.

Alternative investments can help mitigate the impact of inflation on portfolios. There are a range of alternatives, and they all do something different and something complimentary. When we think about hedging inflation risk, we tend to focus on a couple of alternative asset classes. First of all, infrastructure and then real estate. Thinking about first infrastructure, there are core elements of this asset class for which contracts are linked directly to inflation.

These contracts are multi-year, and so when you’re getting a price reset in the contract year after year or period after period, the pricing power embedded in those contracts really helps mitigate any negative impact of inflation on investment returns. That’s an important aspect to think about when inflation is high and persistent as it currently is. Similarly, in real estate, not all real estate sectors, I’m thinking about, for instance, rental properties, which again, have a regular periodic reset clause within contracts that allow rent to keep up with inflation, and that means that investment returns can be compensated for high and persistent inflation.

So those are definitely a couple of good alternative inflation hedges. We also tend to think about hedge fund strategies as being a broad hedge against tail risks, including inflation tail risks. And here, it’s because of the extensive diversification that’s built into an eclectic set of hedge funds. We are not typically focused on a single hedge fund strategy. Instead, it’s important to build a sub-portfolio with exposure to a number of different strategies. By doing that, you get much more diversification in portfolios, including diversification against inflation.

In terms of the outlook for alternative investments through 2023, the expected return remains more attractive than public markets. Although the outlook for public market-expected returns, both equities and bonds have improved as a result of the draw down we’ve observed in recent quarters. Public market-expected returns still appear relatively modest compared to the past 10 years. One of the benefits of alternatives, as well as diversification and an ability to hedge risks like inflation, is that they offer enhanced returns.

One of the reasons they offer enhanced returns is because they’re less liquid. You are paid for giving up some liquidity in your portfolio. You are paid by enhanced returns. So, the outlook still remains relatively favorable, and as long as you really focus on building well-constructed, diverse portfolios that include both public solutions and appropriate alternative solutions, then I think there’s a good opportunity to continue to enhance portfolios in a way that’s very additive to performance and very diversifying in the face of a number of risks.