Portfolio Manager Perspectives

Jeff Benjamin

Manager plots strategy for the onset of inflation

Years of quantitative easing will have an effect; many prices already rising

Apr 18, 2013 @ 12:13 pm

By Jeff Benjamin

As Fed watchers and economists continue debating how inflation in the U.S. is to be calculated, it seems inevitable to many that more than four years of quantitative easing eventually will trigger some inflationary pain.

The reality of the Federal Reserve's buying $85 billion a month in Treasury bonds, laid over existing multibillion-dollar QE programs, is a large part of the momentum behind the rush to buy gold over the past few years.

This is the premise on which Michael Hanus, founder of North Peak Asset Management, has built an innovative new strategy, the Inflation Hedges Strategy Fund (INHIX).

The fund, launched a month ago, uses six subadvisers, including two hedge fund managers, to construct a multiasset portfolio designed to shine when inflation gets above the 2.5% level.

With inflation currently calculated by the consumer-price index at 1.5%, such a strategy might not seem like an urgent necessity, especially considering that the Fed's target inflation rate is 2%.

Mr. Hanus dismisses the CPI measurements as questionable and points to the growing support for chained CPI, which measures inflation based on consumers' evolving spending habits.

“If steak starts getting expensive, people will start buying more chicken,” he said.

Citing the price of everything from food to gasoline to energy, he added, “Inflation is already higher than most people realize.”

While the fund is structured to take advantage of higher inflation, it also is designed as a portfolio hedge that can generate income even when inflation is low, he said.

The portfolio is made up of four broad asset classes, Treasury inflation-protected securities, floating-rate bank loans, commodities and inflation-sensitive equities such as natural resource companies.

The TIPS allocation, managed by Wellington Management, is hedged through the shorting of Treasury bonds to reduce the exposure to interest rate risk.

“TIPS protect against inflation, but not interest rates,” Mr. Hanus said. “We don't like TIPS right now, period, because they're kind of overvalued.”

The floating-rate bank loans slice of the portfolio, also subadvised by Wellington, is a way to benefit from rising rates because the loans are pegged to the London Interbank Offered Rate, meaning the yields will adjust with rising rates.

The commodity allocation is managed on the long-only side by Parametric Risk Advisors LLC. There also is a long-short commodity allocation, managed by Mellon Capital Management and Commodity Strategies AG.

“We like commodities because it's a good link to inflation, but commodities also got killed in 2008, and we think that's unacceptable,” Mr. Hanus said. “We want some of the beta of commodities, which you get with the long-only, but we also want commodities in a long-short strategy.”

The inflation-sensitive equities slice of the portfolio is subadvised by the City of London Investment Group PLC and The Boston Company Asset Management LLC.

“If prices start rising due to inflation, the companies providing the underlying materials like metals and agricultural products such as sugar and corn tend to go up,” Mr. Hanus said. “All of these asset classes tend to do reasonably well when inflation is between 0% and 2.5%, but they do even better when it's above 2.5%.”

Portfolio Manager Perspectives are regular interviews with some of the most respected and influential fund managers in the investment industry. For more information, please visit InvestmentNews.com/pmperspectives.

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