06/30/2011 | By Carisa Chappell
Investors should consider a suite of real investments, including REITs, to efficiently protect their portfolios from inflation, according to an analysis in the spring 2011 issue of the Journal of Portfolio Management.
The article, entitled "Fighting the Next Battle: Redefining the Inflation Protected Portfolio," reviewed how various investments, including REITs, commodity stocks, commodity futures and precious metal futures, have performed during inflationary periods.
REITs and real estate in general have often been thought of as good inflation hedges, posting positive returns when inflation is high, according to Vince Childers, vice president with the real asset strategies group at AllianceBernstein and a co-author of the article.
In an interview with REIT.com, Childers said investors are often confused about which types of investments will provide the best protection for their portfolios against inflation.
"The primary reason investors are confused is because we haven't seen inflation risk realize itself in several decades, so they haven't spent much time researching or thinking about it," Childers said. "It has been off the radar screen."
While different asset classes have the ability to protect against inflation, the paper's authors noted that investors should secure a group of investments that complement a portfolio's existing assets. Doing so provides a more efficient means of hedging against inflation risk without detracting from the portfolio's other goals, according to the article.
Childers said common mistakes that investors make include trying to find a "single magic solution" to hedging inflation risk. He added that no matter the risk tolerance, investors can't solve all of their inflation hedging with a single asset class or a single investment.
When it comes to deciding which assets provide the best defense against inflation, the authors used sensitivity to inflation, reliability as a hedge and cost effectiveness as the three key factors to help determine the effectiveness of a possible inflation hedge.
"The general principal is that what we'd like to see is some kind of balance across these dimensions," Childers said.
The authors likened inflation protection to taking out an insurance policy. The cost in terms of forgone returns relative to a traditional stock-bond mix buys protection against a large loss in the event of an unexpected inflationary shock.