Each of the asset types shown below may be used at times as a strategic inflation hedge, when employed in a diversified portfolio. Each asset type shown can be accessed through mutual funds and offers a distinct set of risk-return characteristics.
Treasury inflation-protected securities (TIPS)
With most fixed income investments, investors bear inflation risk — the risk that the purchasing power of interest income can be eroded by inflation over time. But TIPS provide a means for investors to help mitigate that risk.
How? TIPS can add a real-return component (returns above inflation) to an investment portfolio, because they keep pace with inflation: their principal and interest payments are directly linked to the Consumer Price Index. An allocation to TIPS may provide a portfolio with a "direct" inflation hedge. Should consumer prices rise during the life of the security, TIPS owners can expect to receive higher inflation-adjusted principal at maturity.
It is important to remember that inflation protection is a long-term objective; over the short term, rising rates often have a negative impact on TIPS and funds that invest in TIPS.
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Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions that hinder an issuer’s ability to make interest and principal payments on its debt.
The Fund may also be subject to prepayment risk, the risk that the principal of a fixed income security that is held by the Fund may be prepaid prior to maturity, potentially forcing the Fund to reinvest that money at a lower interest rate.
Interest payments on inflation-indexed debt securities will vary as the principal and/or interest is adjusted for inflation.
The Fund may invest in derivatives, which may involve additional expenses and are subject to risk, including the risk that an underlying security or securities index moves in the opposite direction from what the portfolio manager anticipated. A derivative transaction depends upon the counterparties’ ability to fulfill their contractual obligations.
The Fund may experience portfolio turnover in excess of 100%, which could result in higher transaction costs and tax liability.
Floating-rate and other fixed income securities
Exposure to floating-rate securities, within the fixed income portion of an asset mix, can be considered a hedge against both inflation and rising interest rates.
Floating-rate notes pay variable interest that is tied to a short-term base rate, like the London interbank offered rate (Libor). As the Federal Reserve raises short-term interest rates to attempt to combat inflation, the interest paid on floating-rate notes generally also increases. Investors' income is thus enhanced at the very time when inflation appears. Due to this unique structure, floating-rate securities have historically performed well during periods of rising interest rates — an offshoot of inflation.
Learn more about floating-rate and other fixed income securities:
Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions that hinder an issuer's ability to make interest and principal payments on its debt.
The Fund may also be subject to prepayment risk, the risk that the principal of a fixed income security that is held by the Fund may be prepaid prior to maturity, potentially forcing the Fund to reinvest that money at a lower interest rate.
High yielding, noninvestment grade bonds (junk bonds) involve higher risk than investment grade bonds.
The high yield secondary market is particularly susceptible to liquidity problems when institutional investors, such as mutual funds and certain other financial institutions, temporarily stop buying bonds for regulatory, financial, or other reasons. In addition, a less liquid secondary market makes it more difficult for the Fund to obtain precise valuations of the high yield securities in its portfolio.
International investments entail risks not ordinarily associated with U.S. investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations.
Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.
The Fund may invest in derivatives, which may involve additional expenses and are subject to risk, including the risk that an underlying security or securities index moves in the opposite direction from what the portfolio manager anticipated. A derivative transaction depends upon the counterparties’ ability to fulfill their contractual obligations.
Because the Fund may invest in bank loans and other direct indebtedness, it is subject to the risk that the Fund will not receive payment of principal, interest, and other amounts, due in connection with these investments, which primarily depend on the financial condition of the borrower and the lending institution.
Infrastructure assets
Infrastructure is another type of "real" asset that is linked to inflation. For example, toll roads often have contracts in which tolls automatically adjust for inflation, while regulated utilities like water often have regulated pricing formulas that allow inflation-related price adjustments.
Such rate increases effectively "pass through" to investors, providing a nearly direct link to inflation. For the right investor, a fund that invests in infrastructure assets may be considered a direct inflation hedge, typically held as a small allocation in an investment portfolio.
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International investments entail risks not ordinarily associated with U.S. investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations.
Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.
Narrowly focused investments may exhibit higher volatility than investments in multiple industry sectors.
Because the Fund concentrates its investments in securities issued by companies principally engaged in the infrastructure industry, the Fund has greater exposure to the potential adverse economic, regulatory, political and other changes affecting such entities.
“Nondiversified” funds may allocate more of their net assets to investments in single securities than “diversified” funds. Resulting adverse effects may subject these funds to greater risks and volatility.
Real estate investment trusts (REITs)
Real estate securitization continues to grow as REITs and other publicly traded real estate companies raised a total of $47.5 billion globally in 2010 — more than half of that outside the U.S. (Source: Institutional Real Estate, Inc. as of March 2011).
REITs can offset changes in inflation through rent increases on their properties, a factor that has historically upheld REIT dividends.
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Narrowly focused investments may exhibit higher volatility than investments in multiple industry sectors.
REIT investments are subject to many of the risks associated with direct real estate ownership, including changes in economic conditions, credit risk, and interest rate fluctuations.
A REIT fund’s tax status as a regulated investment company could be jeopardized if it holds real estate directly, as a result of defaults, or receives rental income from real estate holdings.
“Nondiversified” funds may allocate more of their net assets to investments in single securities than “diversified” funds. Resulting adverse effects may subject these funds to greater risks and volatility.
Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.
International investments entail risks not ordinarily associated with U.S. investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations.
The Fund may invest in derivatives, which may involve additional expenses and are subject to risk, including the risk that an underlying security or securities index moves in the opposite direction from what the portfolio manager anticipated. A derivative transaction depends upon the counterparties’ ability to fulfill their contractual obligations.
Investments in small and/or medium-sized companies typically exhibit greater risk and higher volatility than larger, more established companies.
Liquidity risk is the possibility that securities cannot be readily sold within seven days at approximately the price at which a fund has valued them.
Global equities
Most equity investors buy stocks with the idea of outpacing long-run inflation. Short-term stocks may not always fare better in an inflationary economy.
Global equity diversification may provide investors exposure to broad commodities trends and to countries unburdened by high debt. Emerging markets, for instance, tend to provide the most exposure to both energy and materials, but established foreign equity markets may also benefit from economic growth trends fueled by commodities demand.
Learn more about global equities:
International investments entail risks not ordinarily associated with U.S. investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations.
Investments in small and/or medium-sized companies typically exhibit greater risk and higher volatility than larger, more established companies.
Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.
The Fund may invest in derivatives, which may involve additional expenses and are subject to risk, including the risk that an underlying security or securities index moves in the opposite direction from what the portfolio manager anticipated. A derivative transaction depends upon the counterparties’ ability to fulfill their contractual obligations.
