Alternative Strategies: The Best Inflation Hedge - Nicola Wealth

Alternative Strategies Part 3: The Best Inflation Hedge


Read Part 1 of our series on Alternative Strategies here.

Read Part 2 of our series on Alternative Strategies here.

Why alternative strategies may be especially helpful at hedging inflation and safeguarding your wealth at this stage of the economic cycle.

Image of hot air balloon deflated for inflation hedge article.

Long absent from the Canadian economic landscape, inflation is now a fact. In August, Canada’s inflation rate hit 4.1%, the highest year-over-year increase in 18 years. And while economists debate whether this is a blip, as industries disrupted by the pandemic work out the kinks in their reconfigured supply chains, or the new normal as working-age populations begin to shrink, it’s already influencing stock and bond prices.

Inflation is an enemy of the mainstream asset classes, not only because it forces investors to raise their benchmarks for the returns required to simply retain their buying power; it also prods interest rates upward, devaluing fixed-income investments along with certain equities such as utilities and telecoms. It weighs on the profitability of heavily indebted companies or those unable to reprice their revenues.

Relatively speaking, though, alternative strategies tend to thrive in inflationary environments. Research by Swiss Bank UBS in 2018 indicated that hedge funds tend to maintain their absolute returns during inflationary periods and do even better on a relative basis. Four out of five alternative strategies outperformed the S&P 500 over the previous three stretches when the Federal Reserve hiked interest rates and all soundly beat the bond and money markets.

Indeed, rising rates offer new opportunities for hedge funds to make money. One way they do this is applying a long/short equity strategy to sectors and companies that benefit and suffer, respectively, from higher rates—holding long positions in banks and insurance companies whose revenues are set to grow, for example, while shorting companies are forced to refinance their debt at higher rates. The inflation we see today is having the effect of undoing the correlated returns among major asset classes, subsectors and national economies that we’ve grown accustomed to in recent years, which opens up arbitrage opportunities where assets become mispriced relative to each other.

As a general rule, the increased volatility in asset prices that inflation engenders favours active over passive or systematic management. There may be no more active form of investment management, requiring asset managers to constantly make informed judgment calls, than alternative strategies.

Importantly, this is not a time to look to your traditional fixed income allocation to help smooth out the bumpiness in one’s portfolio. You need to consider strategies that will actually grow your capital, regardless of the macroeconomic environment, and alternatives may fit the bill.

This material contains the current opinions of the author and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. All investments contain risk and may gain or lose value. Please speak to your Nicola Wealth advisor for advice based on your unique circumstances. Nicola Wealth is registered as a Portfolio Manager, Exempt Market Dealer and Investment Fund Manager with the required provincial securities commissions.