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“Still, I can’t help but look at that all-time nominal gilt loss in 2022 and think it’ll put some people off bonds for life.”
It did me!
Well, maybe not for life… but my supposed protection simply did not work.
@TA – great analysis, thanks.
So my portfolio of 40-50% World Equities and more or less equal parts of Money Market/Short Gilts, Commodities and Gold should see me muddle through. I’ll have at least one inflation out-running asset for each inflation instance. Just need to reduce MM and buy Commodities and grit my teeth for those years of Commodity under-performance…
Apart from Ultra-short, I don’t dare buy any bonds / bond funds (I leave it to the Defensive ITs I have to hopefully make the right choice regarding that).
I swapped my bond funds for Gold in ~ 2021
Inevitably I’m going to mention Trend Following as an inflation hedge. Pure TF funds had a bumper year during 2022, when inflation was running around 10%. The Société Générale CTA Trend Index was just over 20% for that year.
(perhaps a safer bet with less downside than Commodity ETFs)
70% ILGs/TIPS ladder and 30% equities in cheap index funds. Plus some cash and gold. I’m not going to shoot the lights out but, heck, I can sleep at night. (Until, that is, the UK and/or US default on their sovereign debt .)
Inflation gilts were on a real yield of minus 3% before our most recent brush with inflation due to very low interest rates and artificially generated demand for gilts that provided buyers for an overvalued asset class. A normalisation of interest rates was going to be painful…..
However now gilts have a real yield of over 2% at the long end…. and US tips at 2.75% at the long end ?
On the face of it a guaranteed long term return of inflation plus 2%+ is not unattractive but oddly it is at the moment !!!
If we were to experience stagflation then those linkers might be handy….it might be prudent not to try and fight the last battle, we should avoid recent events blinding us to other possibilities.
Gold is useful as a general crisis hedge, and because it has been reliably uncorrelated with stocks. While a criminal is running the US and wrecking the global order, we should certainly expect more crises. And with a 10% allocation to gold, I can slightly increase stocks, so it indirectly helps beat inflation (well, hopefully, if stocks match their historical averages).
In the recent turmoil, bonds dropped together with stocks again. That’s the problem with historical correlations – market regimes can change, and with that the behaviour of assets.
In contrast, linkers do a useful job in the portfolio. I think 2% real is attractive – would be interested to read why one may think otherwise?
I have a feeling this may be a daft question, but has anyone a clue why money market funds appear to have done well in the most recent inflation round against the -4.1% over all high infation periods?
@Hariseldon – that’s a great point. Longer maturity bonds look much better value than they did but we all got burned. I wonder if it’s the equating of bonds with safety and equities with risk that has made the bond crash more scarring than a stock market rout?
@Onedrew – Money market funds didn’t do well really – the 2022-23 chart shows they lagged inflation by some margin. My guess is they just feel better relative to bonds. While the rise in interest rates makes people feel like their savings are worth something again.
@JPGR and Brod – your approaches make tons of sense to me.
Thank you @TA for the voice of reason whilst the lunatics run the asylum. De-risked a few months ago to a position very similar to Brod which added some resilience if not immunity. Sadly the lunatics may have reestablished the timeframe of my continuingly eponymous handle!
A question for any linker experts, if I might take the opportunity while vaguely on-topic:
If I’m focusing on tax-protected funds (ISA, SIPP) is there any reason to avoid the 8 month lag linkers, i.e. do they come with any disadvantages compared to the 3 month versions? I ask because on HL it’s only the 8 month versions that can be traded online (and the 2030 and 2035 ‘8 monthers’ could play a role for me, if I’m not missing anything).
@tetromino (#10) the 8th month lag gilts are among the most illiquid in issue, so have higher bid offer spreads. So you’ll pay relatively more for them than the more liquid issues.
@Hariseldon (#5), I tend to agree that long dated real yields look attractive versus recent history. The catch, as TA points out, is you need to be able to hold them to maturity.
As to why linkers continue to sell off, the way I consider whether the real return looks sensible is comparing to the real rate of interest required to keep inflation under control. Pre BOE independence it was 3-4% in the UK. One of the two remaining 8-month linkers has a 4.25% coupon which I assume corresponds closely to the real yield when it was issued. Post BOE independence (1997) the real yield fell, and post GFC it cratered due to ultra loose monetary policy (low base rates and QE). So the level of real yields that provides the most sensible gauge of an equilibrium level is post 97 pre 2009.
The returns on the money market account should be a reasonable proxy for the BOE base rate. So you can look at the gap between the green and black line in the chart above. By eye looks to be 2-3% . So if you believe (short-dated) real rates of interest will average 2.5% you may paying over the odds. But it’s a premium I’m prepared to pay to hedge against the uncertainty.
A clarification question:
“World stocks (in GBP) did better than I expected – I suppose because I’m more used to reading about the atrocious performance of USD-priced equities when inflation rips”
So, are the world stocks in this analysis hedged or unhedged to GBP? I assume (hope!) unhedged (and that in the analysis you convert to GBP at prevailing exchange rates). Given the standard advice seems to be to leave your global equity exposures unhedged.
@2 more years – heh, I hear you on the dilemma. It’s tricky to make the leap. Perhaps the guards have unlocked the doors but the in-mates are refusing to leave?
@tetromino – outside of a tax shelter then the chunky coupons for 8-monthers could be an issue, but not in your case. Other than that, the inflation read is more stale versus 3-monthers. Personally, I’d go for 3-monthers where I had the choice but am happy to own 8-monthers when they’re the only option to cover a particular year.
@CGT101 – I meant World equities priced in GBP – so unhedged, converted like you say using prevailing FX rates. I’ll always note a hedged asset e.g. I’d say something like World equities (hedged to GBP). Like you, I subscribe to the standard advice of leaving equities unhedged.
@2 more years – that’s the problem, resilience (or conservatism) can cost. I de-risked from 100% equities to about 50% two years ago when I took my lump sum. It’s been an expensive change. In retrospect, of course.
I was a couple of years early for the maybe-upcoming global depression. Or prehaps the global markets will go on and maybe-add another 30-40% from here. Who knows. Yeah, I’ll miss some of the maybe-upside, but I’ve bought probable-resilience rather than maybe-riches while keeping enough in the game to participate in some of the maybe-riches. I hope.
@TA @Prospector thanks for the helpful replies. Maybe I’ll accept the admin hassle of setting up easy access to the 3 month linkers. Sounds worthwhile if I take a longer view.
Just so, although perversely grateful for the timing of the chaos – at least still have additional contributions in the armoury. If this had happened next year, then rather more tricky. Thoughts go out to anyone who FIRE’d this New (calendar) Year.
Just thinking out loud, but I was taken aback when writing this, that the only two inflationary events that you couldn’t recover from quickly – just by holding equities – were WWI and stagflation. And those two were 50 years apart.
The inflation-hedging diversifiers really are insurance policies, but feel more like car insurance than house insurance. That is, there seem to be a lot of maniacs out there, all intent on cutting me up.
@TA – good point. And since my State and small Civil Service pension will cover my essentials comfortably, I may be over-insuring and just not like the volatility…
Maybe I’ll look at upping my equities. After I receive my pensions, natch.
Is there anything useful that can be said about what the drivers of each of these inflationary scenarios was, and the relationship between these drivers and what turned out to be effective inflation hedges?
Just wondering if it’s helpful to see “inflation” as more of a symptom, and it’s really these underlying drivers we want to hedge against. Appreciate this is far from straightforward, but there’s a lot of variety in these inflationary episodes, and it might be helpful to ask what kind of inflationary episodes we’re most vulnerable to looking ahead and hence which assets can best hedge.
Might be interesting to see how (unhedged) USD money market funds did in each of these inflationary periods.
@TA: This reminds me of your most excellent Optimising the AWP piece, where the “sweet spot” for CAGR & Sharpe was UK equities 60%, MMF 5%, Gold 10% and Commodities at whopping 25% (and no Gilts/Fixed Income!) This current piece on inflation ‘hedging’ (resilience?) eloquently and thoroughly brings out the often neglected attributes of this under invested and under covered asset class.
Using WGEC ETF (1.5 x 60/40 Global DM equities / AAA Global DM bonds) and the new Winton Trend-Enhanced Global Equity UCITS fund (“WTEGE”, with a h/t to @Algernond) (1x Global DM equity + 1x trend, i.e. levered for capital efficiency); one could more or less go 60/5/10/25 capital in equities, MMF, gold and commodities with 50 WGEC ETF and 10 WTEGE Fund / 5 CHS2 ETF / 10 GLD ETF (gold plus yield with covered call writing) and 25% UC15 ETF.
In the process, you’d gain (through rolling futures exposure in WGEC ETF) a ‘bonus’ of 30 exposure to Global DM bonds and (through Winton also being levered) 10 to trend following (the actual exposures then being 55 Global equities / 30 Global bonds / 5 MMF / 10 Gold+yield / 10 trend following / 25 broad commodities – for a total of 135, using only 100 capital).
https://open.substack.com/pub/klementoninvesting/p/good-vs-bad-inflation?r=4a04sn&utm_campaign=post&utm_medium=email
Good piece here by Klement on investing about “good” and “bad” inflation
@CB – Thank you for sharing. The Credit Suisse Yearbook published a great chart that adds context and clarity to the equity/inflation relationship described by Klement:
https://gyazo.com/818dbba444b5a9f1aea508e7b01fc577
Essentially, equities do well when inflation is low (equates with Klement’s good inflation) and are miserable when inflation is very high (Klement’s bad inflation.)
It seems to me that there’s also a leading indicator effect. That is, equities can soar when inflation is high but falling i.e. the world is getting back to normal, supply and demand are coming back into balance.
@DH – thank you for the kind words! I appreciate it. I must look into WGEC. How transparent is it? By that I mean, how confident can a prospective investor be that the engineering won’t blow up in their face? I guess I’m asking, are you all in on such strategies? Or do you commit a relatively small amount on the grounds that it looks interesting but you temper that with the knowledge that fund innovations have a chequered history?
@DH/TA – There’s an interesting episode on Top Traders Unplugged (TTU149) from 9th April on the revival of these Return Stacked / Portable Alpha / Capital Efficient funds.
They discuss why they should fare better at the next ‘crash’ than during the GFC.
@TA: well, personally, I’d never be all in TF (the Winton fund). It’s a possible smallish addition alongside passive cap weight tracking.
But I am much more confident in WGEC and I do tend to think that capital efficiency is perhaps the best idea since ETFs at the start of the 90s.
The key points:
– These (I’m speaking for WGEC and WTEF ETFs here) are emphatically not daily reset leverage. They do not have the volatility drag of daily rebalancing.
– These are not 3x or 2x levered.
– These do not leverage the high volatility asset, like equities. Instead they lever the lower volatility asset, i.e. bonds.
– They do not aim to lever performance of the asset per se. They simply aim to allow exposure to a usually negatively correlated pair through having to use less than 2x capital in order to access exposures of 1x each for the 2 negatively correlated assets.
– They achieve the leverage cost efficiently through the use of rolling 3 month futures not expensively through borrowing to lever up the underlying as with daily reset LETFs. WTEF’s OCF is 0.2% and WGEC’s is 0.25%, which is not bad (the Winton product, however, is terribly expensive, at 1.1% OCF but, OTOH, all TF funds are expensive anyway).
– Capital efficient ETFs have been going a while now in the US without problems. That may be tempting fate. In any event, so far 1.5 x 60/40 US equity / bonds in WTEF has outperformed 100 US equity for me with less volatility (compared to XSPX ETF, which I’m using for most of my US stocks exposure, which, for context, is/was about 50% of equities in portfolio overall). Obviously, since February 16th ATH my US equity investments have been taken to the slaughter house by Team Trump’s actions, but its less for the capital efficient version despite the bond carnage.
– In that last regard, capital efficient ETFs aim for less volatility and better risk adjusted metrics than 100% equity exposure albeit that back testing the US version with the S&P 90 from 1928-57 and the S&P 500 from 1957-2021 showed slightly better pure performance (CAGR) for 1.5 x a 60/40 (with intermediate bonds for the 40) than 100 in US large cap equities alone, and for significantly reduced volatility. I’ve previously linked to a couple of reviews in the US on NTSX ETF, which is the original US version of this (WTEF ETF is the much more recent GDP listed UCITS ETF over here on the LSE).
– WGEC ETF should be more diversified still as its all DM large caps and a mixture of the highest rated DM government bonds.
So I am keen on WGEC.
The Winton product is very new indeed and I need to look into it more.
If it works like RSST ETF in the US then I might be interested in it as an upto 10% building block.
However, the prospectus is nearly 150 pages, so there’s a lot to digest first before taking any decisions and, fundamentally, TF is another avenue of diversification, and not a substitute per se for cap weight tracking IMHO.
Long term aim is to keep overall portfolio leverage at not less than 15% (1.15x) and never more than 50% (1.5x).
That should say GBP listed not GDP listed. Apologies.
I’m with Friedman in that inflation is first and foremost a monetary phenomenon. One could argue that the oil shock of the 70’s was just a natural reaction to the abandonment of the gold standard.
One’s definition of inflation also matters. Gold, stocks and bonds were clearly inflated by QE post GFC and Covid. Given the amount of leverage globally, it’s clear inflation is the least bad way out.
Gold and it’s digital equivalents surely have to be good bets. Stocks with pricing power likewise, though dependent on the price paid.
@DH – I’d be interested to understand the mechanics of these capital-efficient funds. The OCF may not cover trading costs or other costs implied in the futures.
From first principles, I find it hard to see how one can create capital out of nothing, without paying (in whatever way) the market interest rate?
@sparshwein it’s a question as old as finance – how much leverage is sustainable.
As long as the return on your assets exceeds your cost of funding (on the borrowing) you benefit because the net return is geared up.
I had a look at the Wisdom Tree website. What’s interesting with these funds is that the leverage being employed is getting exposure to government bonds using derivatives such as futures.
Assuming the fund is trading these in typical fashion the funding costs will thus reflect secured overnight funding rate (SOFR) for US, Sterling Overnight Index Average (SONIA) and similar benchmark rates for other currencies.
So the funding costs will closely track central bank base rates. So pretty much borrowing at base rates. This is less than I could borrow at (significantly less than I could borrow at unless I put my house up as security).
So what’s the catch? Futures are marked to market and margin is required to be settled in cash daily. The fund holds a 10% cash buffer.
So in a world where bond yields rise, at the same time as equity markets fall the fund may have to sell equities at a loss to raise cash to meet margin calls.
So the real cost in my view is the built in exposure to sequence of returns risk.
@Finumus’ Monevator piece on Trend Following on the 14th March 2024 is illuminating on the mechanics of the use of futures: “The futures contracts and other synthetic instruments that trend followers trade are highly capital efficient. They are all, essentially, just a bet on the direction of a thing, not the purchase of the thing. This means you only need to post a tiny fraction of the notional as ‘margin’”.
As I understand it (and I am a bear of little brain, and profess no expertise here) the problem with daily reset for your ‘typical’ LETF is the constant leverage trap, which is why those aren’t meant to be held more than one day at a time, even though (of course, human nature being what it is) retail investors ignore this sage advice and thereby court eventual, and near inevitable, disaster.
In contrast, capital efficient products are actually designed to be held long term.
They are not, like daily reset LETFs, intended as speculative or short term hedging instruments for traders moving into and out of markets constantly.
P.S. (ran out of edit time to get in above): at the risk of sounding like a conspiracy ‘nut’ here, I guess historically the reason the daily reset LETFs leaked out to retail long before the current crop of futures based capital efficient products is because daily reset carries so much higher management fees, i.e. 95 bps in the early days of those products in the US, and 60 bps to 75 bps now.
In contrast the OCF of the capital efficient products is starting at a reasonable enough 20 bps or 25 bps (for WTEF and WGEC respectively).
So there’s never really been the incentive to make available what is, from a marketing perspective, a more boring capital efficient product as compared with the (dangerous) thrill factor on the sales pitch for daily reset 2x, 3x or 5x levered ETFs, especially on volatile single stocks.
Buy a 5x TSLA or NVDA LETF and you might as well throw your money onto a bonfire if you try and hold long term.
But it sounds exciting.
In contrast a 1.5 x global equity 60% / global bond 40% (a 90/60 in effect) sounds – and in a way is – all rather dull, which is, at its best, what investing should be.
@Prospector and @DH – that’s helpful, thanks.
According to Perplexity “The “cost of carry” (which includes funding costs such as repo rates) is embedded in the futures price itself”.
So if a 150% levered funds invests the extra 50% into UST futures then the return on the bond position is basically the term premium minus transaction costs and fund fees. To me this looks quite slim as a compensation for duration risk and political risk.
One would still get the diversification benefit, that is IF bonds work as diversifier, which they haven’t in recent years and are unlikely to do in a crisis that is caused by the US government.
Greater capital ‘efficiency’ of return stacked products like WGEC ETF should enable making room for more %ages and numbers of non-bond (potential) equity diversifiers (i.e. commodities, gold, trend, and listed global macro HFs – e.g. BHMG).
In a 60/40 you run out of capital after just two asset classes. If bonds let you down then there’s no ‘plan B’.
With capital efficient ETFs the method employed is to leverage the low volatility asset class through futures, but the aim is not about leveraging any asset class per se (even though you are doing so for the bonds), but rather instead to make room for both more and different diversifiers.
The alternative to capital efficient ETFs are a pizza slice portfolio with a little of everything.
Nothing as such wrong with that, and it has its attractions.
But it does necessarily mean having only a small allocation to equities, which for two centuries hitherto have had highest return in expectation.
It’s an interesting approach but there is a lot of complexity.
Intuitively, 90/60 will bring little positive return from the diversifiers against the drag of the borrowing cost. And it puts more pressure on the diversifiers to work as expected when stocks tank, or the portfolio is in serious trouble. We know that historical correlations can flip. 90/60 is riskier than 60/40.
The other option is to increase stocks e.g. 70/30 if one wants to trade higher average expected returns against a higher risk of a bad outcome.
Seems like a project for a long weekend (at least) to compare the options.
@Sparschwein #33:
Although WGEC ETF could be used as a ‘one fund solution’ for a 90/60, it likely works better (in terms of having the maximum dimensions to diversification) as the 60 itself, or possibly by combining with a smattering of the Winton + Trend Following to make up the 60 i.e.:
50 / 10 / 5 / 10/ 5/ 20 comprised of:
WGEC ETF / Winton + TF fund / HICL IT / iShares Physical Gold GBP Hedged ETC / BHMG IT / UC15 ETF then gives:
55 Global DM large caps / 30 intermediate Global AAA government bonds / 10 TF / 5 infrastructure IT equities / 10 Gold / 5 macro HF / 20 commodities.
With seven different and hopefully either negatively or minimally correlated asset classes in total, but still with 60 in equities overall, that’s likely going to be a better way of doing it.
@Sparschwein #33: just another couple of thoughts if I may.
For greater diversification benefits on the global macro hedge side, maybe alongside BHMG for the 5 allocated to that bucket also consider Dutch listed Flow traders (FLOW, discussed in the comments on Moguls for BHMG) and possibly also (David Stevenson pick IIRC) Plus500 (PLUS) for basically similar reasons. In the past I’ve also looked at FX specialist Record Plc, which sports a fat dividend (but I haven’t brought so far).
Thinking here that it’d be quite bold to put a whole 5 into a single alternative IT.
Probably best to buy these either (for BHMG) when both volatility is low and discount wide or (for FLOW) the former.
On Gold, perhaps consider diversifying across vehicles and time by:
– Also looking at gold miners (GDX) when miners look cheap compared to their proven below surface gold reserves (this is the one bit of my own portfolio which has really performed well since the 16 Feb 2025 ATH on SPY, far outstripping gold itself).
– Maybe sizing the gold sector exposure at either 5 or 10 rather than just a fixed 10 using a trigger to go from 5 to 10 when the Dow/Gold price ratio goes over 15:1 and then to revert from 10 back to 5 for the Gold sector weighting if/when that ratio falls below 5:1.
Also, putting a full 10 into such an expensive Winton TF fund (even with the ‘bonus’ of a matching 10 in global equities via futures’ leverage) might be just too much to stomach on the costs’ front.
You could instead do 5 in the Winton fund (which would reduce the overall portfolio leverage in my example from 1.35x to 1.3x) and then put the balance of 5 into EM debt (which in the 19/4/25 MV w/e reading links is highlighted as a bit of a bargain at the moment).
IIRC, in this regard, MV has a piece on EM debt ETFs by @TA.
Sorry that none of this occured to me when I last posted here on Saturday.
For ‘keeping it fairly simple’ exposure to commodities, I’ve been thinking of going into ENCG (L&G Multi‑Strategy Enhanced Commodities ETF) and BRWM (BlackRock World Mining IT).
Do you think that’s basically ‘good enough’ or could I make any better choices?
@dlp6666: if you haven’t already then have a look at Part 3 of @TA’s “Which Commodities ETF” series back on 25th July 2023. He sets out in some detail there why he prefers UC15 ETF and CMFP ETF to the rest.
FWIW I hold both UC15 ETF and also BRWM IT, and for completeness I do also have an active choice satellite holding in Gold miner/junior Gold miners (GDX and GDXJ ETFs) on the grounds Gold miners are cheap compared to their reserves presently, but I don’t consider these as a Commodity element to the portfolio (even though most price sites list Gold as a Commodity).
@dlp6666 – FWIW I split the position between UC15 & ENCG in 2023, UC15 has consistently done better and by now the difference is -2% vs -15%. ENCG was quite new then, their approach sounded good and I took a punt on it, probably a mistake.
I’d echo @DH’s point, commodity stocks are “better than nothing” as inflation hedge, but expect a high correlation with the stock market. Same applies to gold miners.