2021 reaffirmed that the onset of COVID has clearly marked a new macro regime of rising inflation, rising interest rates, and elevated volatility. This decade already looks markedly different than previous:
Global bond benchmark Bloomberg Barclays US Agg delivered just its fourth negative year (-1.54%) in four decades in 2021.
US CPI reached 6.9% last month, the biggest annual gain since 1982.
Broad commodity indexes outperformed equities, breaking out of a decade long bear market and potentially putting the first bottom in the commodity to equity ratio since the tech bubble.
We believe these themes will persist. For many investors, a new playbook for diversification is needed.
Monetary and fiscal policy have been accommodative, and this has buoyed equities. But as inflation continues to strengthen its grip this safety net will be tested. Further, as highlighted recently in our outlooks, there have been few instances in which inflation has been successfully stabilized without a recession.
In our August blog, we reviewed the performance of ten ETFs popular for inflation hedging. With CPI since surging, "transitory" being put to rest, and continued uncertainty about methods to manage inflation risk, this month we provide an update. See Table 1 for key performance metrics.
Notably, as energy captures headlines and dominates conversations, we’ve included two popular leveraged energy ETFs in our analysis. We’ve also included the BTOP 50 CTA Index alongside our flagship Auspice Diversified given their track records of outperformance during inflationary periods.
Broad Commodity ETFs
COM - Direxion Auspice Broad Commodity Strategy ETF
PDBC - Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (largest broad commodity ETF)
GSG - iShares S&P GSCI Commodity-Indexed Trust (tracks SP GSCI commodity index)
DJP - iPath Bloomberg Commodity Index Total Return ETN (tracks BCOM commodity index)
Gold and Natural Resource ETFs
GLD - SPDR Gold Shares ETF
GDX - VanEck Vectors Gold Miners ETF
NANR - SPDR S&P North American Natural Resources ETF
Popular Inflation Themed ETFs
TIP - iShares TIPS Bond ETF
IVOL - The Quadratic Interest Rate Volatility and Inflation Hedge ETF
Energy Stock ETFs
XLE - Energy Select Sector SPDR Fund
DIG – ProShares Ultra Oil and Gas ETF
GUSH - Direxion Daily S&P Oil & Gas Exp. & Prod. Bull ETF
Commodity Trading Advisors (CTAs)
Auspice Diversified Program (Series X)
BTOP 50 CTA Index
Table 1: Key performance metrics, 2020 - 2021
Key Considerations:
1. As a group broad commodity ETFs have produced the strongest returns over the period, with the tactical COM ETF a standout for risk-adjusted returns and low correlation. NANR had the highest returns albeit with high volatility, drawdown, and equity correlation. Auspice Diversified offered the best combination of strong returns, risk management, and negative equity correlation. Notably, it also delivered positive performance in Q1 2020 when equities corrected.
2. What’s your risk threshold? How big of a drawdown can you handle? Energy stock ETFs for example performed exceptionally in 2021, but had 60-99% drawdowns in 2020. Many investors believed energy stocks offered a compelling value opportunity prior to COVID and the resulting 60%+ selloff in these popular ETFs. Risk management is key.
3. What’s your return target? Just as high volatility can be problematic, so too can low volatility. The TIP ETF and TIPs broadly are popular, but at just a 6% volatility the beta to inflation is low and will likely not have a meaningful impact on portfolios.
4. Correlation is key. All returns are not equal, diversification is the only free lunch. COM, TIP, GLD, GDX, and the BTOP 50 CTA have low equity correlations, and Auspice Diversified a negative equity correlation that is most accretive to portfolio returns.
Other Considerations:
1. The 2020 –2021 period analyzed covers both the selloff and recovery surrounding COVID. Timing these, as we know, is difficult, and we recommend investors look for portfolio solutions that can be held for long periods.
2. Particularly here in Canada, we tend to think our portfolios have exposure to inflation given the commodity intensity of our economy. While true in some regards, the correlation of resource and energy equities to broad equity indexes is high and diversification benefits low.
3. The above analysis also includes a period in which stocks (MSCI ACWI) had a historically low 0.16 correlation to bonds (AGG). If this relationship were to change and become more positive, as experienced in other inflationary environments(1), the diversification benefits of the 60/40 portfolio will become much lower.
For more information please email info@auspicecapital.com
References
Disclaimer below
IMPORTANT DISCLAIMERS AND NOTES
Futures trading is speculative and is not suitable for all customers. Past results are not necessarily indicative of future results. This document is for information purposes only and should not be construed as an offer, recommendation or solicitation to conclude a transaction and should not be treated as giving investment advice. Auspice Capital Advisors Ltd. makes no representation or warranty relating to any information herein, which is derived from independent sources. No securities regulatory authority has expressed an opinion about the securities offered herein and it is an offence to claim otherwise.
QUALIFIED INVESTORS
For U.S. investors, any reference to the Auspice Diversified Strategy or Program, “ADP”, is only available to Qualified Eligible Persons “QEP’s” as defined by CFTC Regulation 4.7.
For Canadian investors, any reference to the Auspice Diversified Strategy or Program, “ADP”, or Auspice One Fund “AOF”, is only available to “Accredited Investors” as defined by CSA NI 45-106.