How to hedge against inflation?

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Overview of the topics

  • Stocks Highlights: After CTI Fund Management recorded a wave of profits, the manager Sir Chris Hohn paid himself $690 million a year.
  • Economic Data: In November, the Conference Board's consumer confidence index fell to 100.2, the lowest since July 2022.
  • Social Data: Investors have begun to give attention to real estate, which offers 78% inflation protection.
  • Financial Data: Inflation hedging is becoming extremely useful to offset the reduction in purchasing power.
  • Deep Dive: Hedge funds are positive towards the holiday season and suggest investing in AMZN.

Stocks Highlights

Hohn paid himself $1.8 million a day

This year, after his Children’s Investment Fund recorded a wave of profits, the hedge fund manager Sir Chris Hohn paid himself $690 million, equating to nearly $1,8 million a day. The payout is the biggest ever collected by the billionaire Hohn,

The payment from the fund is estimated to be 15,000 times higher than the average UK salary and 3,500 higher than the compensation for Rishi Sunak as prime minister. Although the difficult macroeconomic situation, the sum was up from $152 million from the previous year in February and up from $479 million the year before. However, it remains lower with respect to 2019, when Hohn was classified as the world’s highest-earning hedge fund manager. “It would be easy for policymakers to get companies and the super-rich to pay their staff more and a bit more tax”, commented the High Pay Centre’s Luke Hildyard.

Hohn, the son of a Jamaican car mechanic who emigrated to Britain in 1960, is one of the UK’s biggest philanthropies. From 2003, the year in which he set up TCI Management Fund, he has built a fortune of $8,2 billion. But how is the fund making profits despite the worldwide economic situation?

Economic Data

Consumer confidence is falling down

In November US consumer confidence reached a four-month low, with American households less inclined to spend on expensive items over the next semester and rising borrowing costs. However, because of the rise in interest rates, consumers are heightening the risk of a recession. The chief economist Jeffrey Roach noticed that “The weakening trend in confidence foreshadows a recession which will likely happen in the coming year”.

In November, the Conference Board's consumer confidence index fell to 100.2, the lowest since July 2022. Nevertheless, the CCI index is remaining above the COVID-19 lows. The decrease in confidence concerned the 55 and over age group as well as households with incomes below $50,000. They have faced inflation rates that, before October 2022, characterized themselves by annual consumer prices not seen since the 1980s.

This year, the Fed has raised its interest rates by 375 basis points, increasing them from zero to a range between 3.75% and 4%. As a consequence, the worldwide stock markets began to suffer. The Head of Investments (HoI) of UBS, Barry Gill, thinks that “Markets and investors have scrambled to reprice risk, particularly in the growth areas of technology disruption. The S&P 500 formally entered a bear market, and bonds and stocks started to positively correlate for the first time in over 20 years. The primary questions investors are trying to answer concern the durability of the inflationary pressures”.

This year, the fear of a recession led the major stock market indices to lose value. From January, the Dow Jones Industrial Average registered a drop of -7.55%, the Nasdaq Composite -29.59%, and the S&P 500 -17.31%. This week, with the S&P 500 experiencing its seventh negative session in eight, we are facing another round of major layoffs.

Social Data

How are investors facing uncertainty?

Patient investors are waiting for worldwide central banks to shift in a more dovish direction allowing the international economies to inflect higher and global equities to result more attractive.

However, the inflationary rise has driven investors toward old preferences. Indeed, sustainable investors are looking for hidden climate solution assets at discount. They are typically emission-intense legacy sectors that will be recategorized as “green” and will earn a high valuation. On the other hand, hedge funds weathered this complicated period better than equity, which is why investors diversify their portfolios by adding a hedge fund allocation.

Furthermore, investors have begun to give attention to real estate, which offers 78% inflation “protection”, up to more than 80% when real interest rates and variable property risk premiums are applied. However, the trend may change, since we have the risk of being in a period of stagflation, due to rising interest rates.

Observing the UK real estate market, the one with the longest rental income history, the rental income grew by 10% per annum between 1970 and 1990when inflation was higher and slowed to 3% between 1990-2020 when there was lower inflation. The last period includes the 2019 pandemic when retail businesses were shut down and unable to pay their rent. Nevertheless, the nominal growth over the period excluding the pandemic was higher. In any case, this year analysts expect rental income to rise by a one-off 8%.

The trend is confirmed by the most used words on Twitter. Throughout this week, investors have typed 100 times per day “real estate”, together with the citation of the widest indices populating the stock exchange market, such as the Nasdaq, the Dow Jones, and the S&P 500.

Financial Data

Inflation hedging as key to beat inflation

Even if inflation is perceived as a natural event, “inflation hedging” can be extremely useful to offset the reduction in purchasing power and protect the value of investments. According to this strategy, investors should opt for asset classes that outperform the market in inflationary times.

Analysts recommend reallocating 10% of the personal portfolio from bonds to equity. In particular, a 60/40 stock/bond portfolio is perceived as a safe mix of stocks and bonds. The most famous example of this allocation is the Dimensional DFA Global Allocation 60/40 Portfolio.

During times of inflation, national investments can become more costly in the long term. American investors, therefore, tend to increase international exposure to economies that have a different economic cycle, like South Korea, Italy, and Australia. The simplest way to diversify personal portfolios in foreign markets is through ETFs and mutual funds. However, even if 60% of capital markets are represented by international activities, the quota of foreign equities and bonds in the portfolios of US investors is just 21%.

Another method to beat inflation is represented by TIPS, Treasury inflation-protected securities. They are bonds that increase in value depending on inflation and are considered amongst the safest investments in the world. In particular, their principal amount is reset each time there’s a change in the Consumer Price Index. However, they are sensitive to current interest rates, and this year they are down more than 19%.

If rates start to rise, buying senior secured bank loans can be a good way to earn yields while protecting your investments from a price drop. One of the most important funds in this category is the Lord Abbett Floating Rate Fund, known as LFRAX.

Even if the best strategies against inflation depend on the time frame, other assets used by investors in difficult times are commodities, especially gold. However, gold works at its best as an inflation hedge only over a very long-term, such as a century or more.

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Deep Dive

The 5 best stocks that hedge funds suggest

Even if it has been a challenging year for investors, there is a “widespread” belief that the holiday season will turn favorable for investments. Cramer, the speaker of CNBC’s Mad Money, pointed out that the bears have started to retreat from the stock market.

Given that investors have positive expectations for the next months, the best stock suggested by hedge funds is AMZN. The shares of Amazon, the world’s biggest e-commerce retailer, rose by 6% in the past quarter, after the company reported revenue growth of 7%.

After Amazon, we can find Microsoft (MSFT), followed by The Walt Disney Company (DIS) and Advanced Micro Devices (AMD). In particular, Microsoft is acquiring Activision Blizzard for $68.7 billion, a deal that is perceived as bigger than Musk’s acquisition of Twitter and that will boost the sales of the company. Invite 3 friends and gain access to the full deep dive!

News of the week

  • S&P 500: S&P 500 closes higher to end longest losing streak since October. [Read more]
  • Stocks: J.P. Morgan says these 2 stocks could surge over 90% from current levels. [Read more]
  • Oil: US fund managers cross the Atlantic to buy European oil stocks.[Read more]
  • Musk: Tesla investors have a message for Musk: stop wasting time on Twitter. [Read more]

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