Where are investors investing as inflation concerns grow?
Rising inflation expectations sent large flows of money into assets that could benefit. Some attract more of this money than others.
Funds invested in inflation-protected bonds, whose face value increases in line with the consumer price index, have seen strong inflows since last May, according to a
report released on Friday. The amount of money that has been invested in these funds over the past year was the highest since 2010.
Investors have shown much more interest in inflation-protected bond funds than in bonds in general. This is not surprising: for most of the two decades or so since 1998, stocks and bond yields have been positively correlated. This means that whenever stock prices come under pressure, bond yields would fall and prices would rise. Allocating some of their assets to bonds offered investors a cushion when stock prices fell.
Lately, however, the model has not held. The degree of correlation between bond yields and equities has been declining since last August and has been negative since February. When stocks sold, bond prices also came under pressure from rising yields. This means that bonds may no longer be a good diversifier in portfolios, making them less attractive to many investors.
Historically, this inverted relationship has tended to appear when inflation risks are high, as they were during the three decades from the mid-1960s to the late 1990s, wrote Parag Thatte, strategist of Deutsche Bank. Inflation raises the possibility of monetary tightening over time, which poses risks for both stocks and bonds.
Funds investing in energy and materials stocks, which generally perform better in an inflationary environment and have experienced cash outflows in recent years, have also seen strong inflows over the past year, particularly since November. Financial funds, which generally benefit from rising rates with inflation, have also carried large sums of money.
Commodities are often seen as a hedge against inflation, but investor confidence in the asset class appears to be weaker this time around. According to the report, funds backed by physical commodities have mostly seen net outflows in recent months, including oil-focused funds, gold funds and silver funds. Industrial metals funds have recently resisted the trend and have registered inflows this year, but investor interest is still quite modest.
Futures traders are also not particularly bullish on commodities, with their long positions benefiting if prices rise well within historical ranges. “While the price dynamics are very favorable, the volatility between commodities is also very high, which has limited exposure,” Thatte wrote in Friday’s report.
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