Inflation can erode purchasing power and drag stocks lower, requiring investors to make diversifying into different asset classes a top priority in a rising inflation environment. But it can't just be a move to more bonds or stock exposure – Fidelity Investments said that investors need to think outside the box.
"After more than 35 years of generally falling inflation, signs of an uptick have unnerved investors. Among the factors that could drive prices higher: strong global growth, rising interest rates, and peak globalization," wrote Fidelity in a recent blog post. "If inflation does pick up, it could have an impact on a wide range of investments. This is why inflation warrants prudent risk management, particularly for retirees or more conservative investors."
[Ally Invest offers powerful charting tools and $4.95 trades. Read Investopedia's Ally Invest review to learn more about this low-cost broker.]
The Boston-based fund company said that, to mitigate some of the risk associated with inflation, investors have to choose asset classes that don't fall off the cliff because of rising inflation. One of those categories that could benefit investors in the current environment is commodities and gold. According to Fidelity Investments, gold and commodities have long histories of posting reliable returns that on average outperform when inflation is rising. What's more, Fidelity said that commodity prices tend to increase when demand drives inflation. Meanwhile, gold has long been seen as a place of value compared with paper currencies that tend to lose value as inflation rises. The fund manager also pointed to commodity-producing companies as a defensive play on inflation.
"These companies, such as those in the energy and materials sectors, benefit from the same trends as commodities, and have the ability to use operational and financial leverage to further magnify the positive impact of rising prices on earnings growth," wrote Fidelity. Other investments that could benefit in a rising inflation environment include short-duration bonds, which Fidelity said are less sensitive to inflation than their longer-term counterparts.
The second subcategory that Fidelity Investments is touting is real estate, which includes real estate investment trusts (REITs). The fund manager said that REITs tend to hold their value even as inflation rises, largely because they own physical properties that bring in rents, which can be raised.
Meanwhile, Treasury inflation-protected securities, otherwise known as TIPS, are Treasuries with a value that adjusts with the consumer price index that act as a hedge against an inflationary environment. Leveraged loans are another option largely because they move with short-term rates. "Although these asset categories have trailed the broader stock and bond markets amid falling inflation, they've outperformed when inflation has risen," wrote Fidelity.