Harnessing the power of ETFs for inflation hedging

Learn the portfolio tools that can help manage the impact of inflation

Many advisors and investors have begun to believe that analyzing the impact of inflation on their portfolios is key to funding their overall investment goals. Investors seeking to capitalize on the changing investment landscape can find a variety of innovative solutions that can potentially enhance their portfolio’s reaction to inflation. Below are insights that contributed to the creation of alternatively-weighted index solutions that may offer an innovative approach to managing your portfolios inflation sensitivity.

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Whether you believe that inflation is a future threat to your investment portfolios will depend on many factors. We offer several investment solutions that may help investors as they decide what is right for them. This guide takes a look at five FlexShares funds built to help investors achieve their financial goals in the midst of inflation.

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Linking to inflation

The introduction in 1997 of Treasury inflation-protected securities (TIPS) in the United States offered investors multiple potential benefits. First, the development was intended to offer investors a security that would enable them to hedge inflation. Second, by taking on the risk of inflation, the U.S. Treasury Department would not have to pay an inflation risk premium on its securities, thereby lowering its expected borrowing costs. Finally, the securities would provide a market-based measure of inflation expectations. It would be possible to gauge market expectations of inflation by comparing the yields on nominal Treasury securities with yields on inflation-protected securities of comparable maturities.

FlexShares iBoxx® Target Duration TIPS Index Funds (TDTT & TDTF) targets Modified Adjusted Duration (MAD) which takes into account the duration component of TIPS securities.

For some investors, however, that hedging has come with an unanticipated expense — the added time, effort, and fees incurred by investors attempting to target the “duration” of their investments to match the risk exposure of their portfolio. But first, what is “duration”? Duration is how sensitive your investment is to a change in interest rates. You will often see it expressed as a number of years — the higher the number the more volatile will be the expected change. Historically, rising interest rates have often meant falling bond prices, while declining interest rates have meant rising bond prices. So, the ability to target a specific duration based on your exposure is key to successfully protecting yourself against the threat of inflation. FlexShares® iBoxx® Target Duration TIPS Index Funds (TDTT & TDTF) targets Modified Adjusted Duration (MAD1) which takes into account the duration component of TIPS securities.

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moving upstream

 

With growing populations and increasing per-capita income, global markets are in the early stages of what is expected to be an extended period of demand expansion for energy, food products, metals and other natural resources such as paper and water. These are the building blocks of flourishing economies.

FlexShares Morningstar® Global Upstream Natural Resources Index Fund (GUNR) is designed to give investors a focused and convenient way to participate in this potential rising global demand for natural resources. Unlike some funds, we do this by focusing on the upstream segment of the resource supply chain. The upstream segment refers to the beginning of the supply chain, when resources are extracted from the ground and sold to producers. By adding focused exposure to the upstream market, we believe investors can minimize the risk of rising resource prices to their downstream investments. 

FlexShares Morningstar Global Upstream Natural Resources Index Fund (GUNR) is designed to give investors a focused and convenient way to participate in this potential rising global demand for natural resources.

Addressing these three prevalent biases underscores several core benefits of our flexible indexing approach. We aim chiefly to help investors manage risk and provide more efficient portfolio solutions. Our philosophy doesn’t confuse the “what” with the “how.” Our approach uses index-based strategies in a variety of targeted portfolio applications, not simply to capture the return of a market segment associated with beta but, systematically, to provide targeted risk exposures that enhance risk-adjusted returns. Both the process and our products are different by design.

This fund is built by focusing on global companies in the key upstream sectors — energy, metals and agriculture — balanced with core investments in the timber and water industries. By taking a diversified approach,2 the Fund seeks to prevent overexposure to any one area in the natural resources field. As the global economies revive from the pandemic and demand for natural resources rise, we think our upstream index fund provides a great way to build your exposure to the growth potential of the natural resources market while playing an important role in helping your portfolio adjust to inflation.

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MISSION-CRITICAL PROJECTS

After decades of neglect, the need to ramp up spending on infrastructure is coming to the forefront as economic growth is being realized globally. Increasingly, institutional investors, sovereign wealth funds and others have been allocating assets to infrastructure.

The term infrastructure refers to fundamental facilities and systems that serve a city, an area, or a country. Infrastructure assets are mission-critical capital projects that move people, energy, goods and data and earn fees for their use through contracts and concessions. Some examples of traditional infrastructure projects are bridges, tunnels and toll roads; airports; pipelines; and electric, gas or water and sewage utilities.

Investors interested in ways to diversify and hedge portfolios may want to consider the FlexShares STOXX® Global Broad Infrastructure Index Fund (NFRA) as both a real asset and as an equity holding.

We believe infrastructure presents a long-term inflation hedge as the revenues infrastructure projects derive are heavily regulated and often tied to the Consumer Price Index (CPI). Investors interested in ways to diversify and hedge portfolios may want to consider the FlexShares STOXX Global Broad Infrastructure Index Fund (NFRA) as both a real asset and as an equity holding.

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GLOBAL PROPERTY

Investing in the real estate sector offers the potential to add growth, diversification, income along with potential hedging against the risk of long-term inflation to a portfolio. We believe that a well-diversified and global approach to real estate investing is a key factor in unlocking the full range of these potential benefits.

The FlexShares Global Quality Real Estate Index Fund (GQRE) is an ETF that may provide an alternative source of income to investors searching for yield in a low interest rate environment.

Our research suggests that real estate equities have been used traditionally as a potential hedge against long-term inflation, as some types of real estate stocks have been shown to be less resistant to rising interest rates. Historically, our opinion is that real estate investments also have paid higher dividend yields than other equity classes, offering an alternative source of potential income. Finally, we believe that real estate historically has had a low correlation to both fixed income and other equity asset classes. As a result, a global approach to real estate investing can offer additional diversification opportunities and we believe may also include less volatility than U.S. real estate alone.

The FlexShares Global Quality Real Estate Index Fund (GQRE) is an ETF that may provide an alternative source of income to investors searching for yield in a low interest rate environment. The Fund tracks the Northern Trust Global Quality Real Estate Index which is designed to maximize exposure to a multi-factor approach including quality, value and momentum factors, within a universe of companies operating in the real estate sector. Northern Trust Investments Inc. (NTI) is the investment adviser for FlexShares ETFs.

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DEFINITIONS

Correlation is a statistic that measures the degree to which two securities move in relation to each other.

FOOTNOTES

1 Modified Adjusted Duration is the market’s estimate of the duration on a TIPS bond based on inflation expectations at that point in time.

2 Diversification does not assure a profit.

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