The Curse of Inflation

Because there are multiple potential sources of inflation, multiple investment vehicles should be employed to hedge against them

“Reasoning in the abstract, the mind cannot stop short of an extreme…But everything takes a different shape when we pass from abstractions to reality.” - Carl von Clausewitz.


It is often said that inflation is the result of too many dollars chasing too few goods. If the same concept is reworded to say that inflation is too few goods being chased by too many dollars, the math is the same, but the perspective changes.

In the late Roman Empire, the government started shaving 5-10% of the precious metals from coins to make new coins. This increased the money supply without finding new sources of gold and silver, which was inflationary. In more recent times, central banks have monetized government debt through large-scale purchases – in some countries leading to hyperinflation of over 1,000% per year. This has led many to say that inflation is always a monetary phenomenon.

On the other side of the ledger, inflation can be the result of a scarcity of natural resources or housing, or insufficient infrastructure to move materials efficiently. Famously, prior to the collapse of the Soviet Union, Russians would pay American tourists $200-300 for a pair of blue jeans that retailed for $25 in the US – a case where there was demand for an existing product that was unavailable in that market.

So, inflation is really an imbalance between supply and demand, with demand funded by additional units of currency. While inflation in the abstract is fine for central bankers to debate, consumers and investors are more interested in how it affects them. Consumers have to deal with inflation in real-time by reducing spending, securing wage increases, or tapping savings; and investors face the prospect of reduced long-term purchasing power for their portfolios.


Inflation is a significant long-term risk to investment portfolios, as it erodes the purchasing power of assets over long periods of time, and needs to be hedged against. Because there are multiple potential sources of inflation, multiple investment vehicles should be employed to hedge against them.

Treasury Inflation Protected Securities (TIPS) are fixed income securities that have their principal value adjusted semiannually based on changes in the Consumer Price Index (CPI). Consumer inflation is far down the supply chain and includes the effects of many variables. And although principal amounts are adjusted, the coupon rate remains the same, and rising interest rates can have a particularly negative effect on TIPS over shorter periods.

Natural resource production is at the upper end of the supply chain and is essential to the entire production process. Scarcity of raw materials is a precursor to inflation throughout the supply chain. An allocation to natural resources, particularly those furthest upstream, can hedge against inflation initiating at the source of production.

Infrastructure investments focus on the supply chain, which encompasses transportation of raw materials, as well as completed goods to points of sale or direct to consumers. It does little good if there are natural resources and/or finished goods in abundance if they cannot be transported for consumption. In addition to offering some hedging against inflation, infrastructure investments are also strategic.

Real estate has long been seen as an inflation hedge. While prices in the sector are less volatile than most stocks, real estate is subject to periodic bubbles, and heavily reliant on both the level of, and changes to, interest rates.


There is no way to eliminate inflation risk in a portfolio, and with no single source of inflation, there is no single way to hedge against it. Each investment vehicle that can offer any inflation hedge has its own strengths and weaknesses. A prudent strategy is to consider incorporating any of those that are suitable.

FlexShares offers six ETFs that may help investors hedge their portfolios against the various sources of inflation, when the abstract becomes reality:

FlexShares iBoxx 3-Year Target Duration TIPS Fund (TDTT) and FlexShares iBoxx 5-Year Target Duration TIPS Index Fund (TDTF) may help hedge against consumer inflation as tracked by the Consumer Price Index.

FlexShares Morningstar® Global Upstream Natural Resources Index Fund (GUNR) provides access to natural resources that are considered upstream in the production process, which allows for a potential hedge against inflation. The strategy also includes allocations to water and timber assets, which are often overlooked by other ETFs.

FlexShares STOXX® Global Broad Infrastructure Index Fund (NFRA) provides exposure to the supply chain itself, as well as the broader logistics of the movement of goods.

FlexShares Global Quality Real Estate Index Fund (GQRE) provides exposure to real estate and its unique economic characteristics. Studies have shown that global diversification reduces the risk of a real estate portfolio.

Real Assets Allocation Index (ASET) provides one-stop shopping for allocations in three of the ETFs mentioned above: GUNR, NFRA, and GQRE.

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