Using Equities To Fight Inflation

Last year, inflation touched its highest levels in four decades and the S&P 500 lost 18.2%. Put those two factors together, and it’s reasonable to expect that clients would be leery about deploying equities to fight inflation.

Then again, as measured by the largest exchange traded funds tracking these asset classes, gold, real estate and Treasury Inflation-Protected Securities (TIPS) all declined in 2022 with only the gold ETF performing noticeably less poorly than stocks. The TIPS ETF beat the S&P 500 by 600 basis points, but its loss was still severe relative to what advisors and clients expect from a normally boring corner of the bond market.

What’s interesting about phenomenon such as rising rates and inflation is that for as ominous as these scenarios are, there are ETFs that are useful on these fronts. In fact, there’s an equity-based ETF explicitly dedicated to helping clients survive and thrive when Treasury yields are soaring.

On that note, a new stock-driven ETF with the objective of fighting inflation debuted on Tuesday. Let’s look into this rookie fund here.

Could Be Fantastic Inflation Fighter

The First Trust Bloomberg Inflation Sensitive Equity ETF (NYSEARCA: FTIF) is the ETF in question. It tracks the Bloomberg Inflation Sensitive Equity Index. That benchmark is comprised of stocks that are expected to benefit, directly or indirectly, from increasing inflation and it removes heavily indebted firms – a bonus in inflationary environments.

Another nifty feature of FTIF is that free cash flow is one of the factors used in the index’s security screening process, meaning there is an element of quality to the fund.

“The top 50 companies with the highest free-cash-flow yield based on a trailing 12-month period are selected, subject to a maximum of 20 stocks from a single sector. The selected companies will be equally weighted,” according to First Trust.

FTIF’s free cash flow focus is important for another reason. Large-cap companies, particularly those hailing from the sectors emphasized in the new ETF, typically pay dividends. Free cash flow not only ensures the near-term viability of those payouts, but growing dividends in the future. Dividend growth has long-term history of beating inflation.

“Inflation refers to the average change in prices over time that consumers pay for a basket of goods and services. When inflation rises, the purchasing power of money erodes, and it becomes important to seek strategies to generate additional income,” adds First Trust.

Speaking of Sectors…

When it comes to funds dedicated to fighting rising rates or inflation, it’s reasonable to expect there will be some of level sector concentration risk. After all, some groups simply perform better in those situations than others.

As for the sectors displaying the most positive sensitivity to the Consumer Price Index (CPI), those are energy, real estate, industrials and materials. Only those groups qualify for entry into FTIF’s underlying index.

The result is some sector-level concentration, but that’s the trade-off for isolating groups positively correlated to inflation. However, another benefit of the FTIF strategy is that it’s value-centric and that’s a good place to be in this environment.

Related: Golden Retirement Planning Ideas, Insights with GSAM