An Inflation-Combating Fund
One of the overarching themes at this week's annual Morningstar Investment Conference in Chicago is inflation, which is rearing its ugly head around the globe.
In recent years, investors have been spoiled by the slow rate of price increases, says conference keynote speaker Mohamed El-Erian of Pimco, a Newport Beach, Cal., firm that specializes in bonds. Now that inflationary pressures are building, investors have been slow to focus on protecting their portfolios against rising prices.
Derek Young of Fidelity says that older investors, who need to preserve capital, should be allocating a portion of their portfolios to inflation protection. Institutional investors, such as managers of defined-benefit pension plans, have traditionally put a portion of funds -- maybe 10% -- into "real assets," such as real estate and commodities, that tend to hold their value in times of inflation. Young says individual investors shaping their own portfolios should adopt a similar allocation strategy.
Young runs an interesting inflation-combating fund, Fidelity Strategic Real Return (symbol FSRRX), which returned an impressive 9% year-to-date through June 26, 12 points better than the Dow Jones Moderate Portfolio index. He divides the portfolio into four separate inflation fighters: Treasury inflation protected securities (TIPS), floating-rate bank notes, commodity-linked notes and real estate securities, which include REITs and high-quality mortgage-backed securities.
Young has the flexibility to maneuver among the four categories. Over the past year, he has generally been heavy in commodities and TIPS. However, he's recently lightened up on commodities and TIPS, which have had an enormous run.
He's finding value now in floating-rate notes, where he generally keeps 25% of the fund. These are bank loans that are repriced every few months according to interest-rate fluctuations in the market. So if interest rates are rising due to inflation expectations -- the state of affairs recently -- the investor is protected against higher rates.
Young has 20% of his fund real estate, noting that commercial property, such as office buildings and hotels, does not suffer from the pressures of massive oversupply that residential real estate does.
The important thing is that inflation appears to be here to stay, and that changes some of the rules of the investing game. Over the long run, inflation can ravage the purchasing power of a portfolio. Investors should consider ways to build some insurance against inflation into their nest eggs.