With Inflation at 6.2%, Bonds Have a Rough Future
November 11, 2021 — U.S. inflation hit 6.2% in October compared with a year earlier.
The consumer price index was up 0.9% last month, meaning that the purchasing power of a U.S. dollar is losing nearly -1% every 30 days. Unfortunately, the Canadian dollar is not doing much better.
Inflation, or a decline in the purchasing value of money, should be investors’ number one concern in the current market environment. Persistent inflation rates above 5% have been consistently above the central bank’s 2% target for months. It is more than just transitory.
Most notably, a high rate of inflation should be setting off alarm bells for fixed income investors.
Undoubtedly, bondholders should be already aware of the potential sting of higher interest rates, given that Treasury bonds reached a bear market decline of -20% earlier this year.
Despite a substantial drawdown already, bond investors still face the additional risk of potential massive losses.
For example, if you own a 10-year Treasury bond, be aware of the tremendous risk of this investment. If the real interest rate (nominal rate less inflation) reverts to its long-term average of 2%, an investor holding a 10-year Treasury note would suffer a loss of -45%. So, if you thought bonds were safe, think again.
With inflation running seemingly out of control, what’s an investor to do?
In May of this year, I provided a playbook for investors for this exact scenario: Inflation Is Surging. Here’s What To Do About It
It is not too late to protect one’s portfolio against the scourge of inflation. Reducing one’s bond exposure in favour of diversifying into inflation-fighting assets could be worthwhile.
Besides, with inflation at 6.2% and the 10-year Treasury note yielding 1.6%, does a negative 4.6% real return sound appealing to anyone? Call me crazy, but I prefer to invest in assets with a positive expected real return.
Accelerate manages five alternative ETFs, each with a specific mandate:
- Accelerate Arbitrage Fund (TSX: ARB): SPAC and merger arbitrage
- Accelerate Absolute Return Hedge Fund (TSX: HDGE): Long-short equity
- Accelerate OneChoice Alternative Portfolio ETF (TSX; ONEC): Alternatives portfolio solution
- Accelerate Enhanced Canadian Benchmark Alternative Fund (TSX: ATSX): Buffered index
- Accelerate Carbon-Negative Bitcoin ETF (TSX: ABTC): Eco-friendly bitcoin
Please see below for fund performance and manager commentary.
The turnaround of sentiment within the SPAC market continues.
The SPAC market’s emergence from a 6-month bear market was undoubtedly spurred by Donald Trump’s entrance into the asset class. Specifically, the recently announced merger of Trump Media & Technology Group with blank check company Digital World Acquisition reignited animal spirits within the market. Digital World Acquisition units, which rallied more than 600% off the deal, have brought retail investors back into the market. The re-emergence of retail investors, who left the market in the first quarter, has buoyed the SPAC asset class and has generated sufficient volume to allow some SPACs to rally above NAV upon deal announcement. The ability to exit a SPAC investment above NAV and recycle the capital into new issues below NAV is the ideal scenario for a SPAC arbitrageur.
A constructive SPAC environment, combined with no adverse events in merger arbitrage, made October’s 1.3% gain in ARB an above-average result.
As we head into year-end, the ubiquity of SPAC IPOs with overfunded trusts ($10.20 NAV, or a 2% return right out of the gate), in addition to 1/2 warrant coverage (which can add 5% to the expected return) leads us to be constructive about future near-term returns for ARB. This positive outlook for ARB stands in stark contrast to traditional fixed income products, such as bonds, which face a bleak future given the inflationary environment and accompanying expected interest rate hikes.
It was a mixed bag for multi-factor performance in September. As such, HDGE finished the month flat, as losses from its short book eliminated gains from the long portfolio.
U.S. alternative risk premia generated alpha of +2.2% last month. The U.S. multi-factor portfolio gains were led by operating momentum, with a 3.1% rally, trend with a 2.4% increase, and value, which tallied 2.0%.
Canadian alternative risk premia lost -3.3%, with long-short quality falling -5.8%, as low quality stocks surged and high quality equities failed to keep up.
Nonetheless, recent monthly performance metrics for HDGE, including gains in March 2020 and September 2021 (when equity indices fell precipitously) exhibited why HDGE’s uncorrelated (or negatively correlated) performance helped hedge diversified investment portfolios while still providing a positive expected return.
ONEC gained 3.7% in September, led by bitcoin’s 45.5% rally.
Additional positive contributors were real estate with +3.6%, risk parity with +3.5%, infrastructure with +3.3%, enhanced equity with +3.2%, gold with +1.5% and arbitrage with +1.3%.
Both long-short equity and leveraged loans were flat on the month, while the mortgage portfolio slightly declined.
We find that on average, Canadian alternative risk premia generally outperform U.S. alternative risk premia, given long-short multi-factor investing is less prevalent in Canada. Essentially, there are more fish and fewer fishermen in Canadian investment waters, leading to a higher expectation of alpha generation from market neutral investment portfolios.
However, expected outperformance did not come to fruition in September, as the Canadian multi-factor portfolio fell -3.3%.
This underperformance of long-short factors within the Canadian market led ATSX’s overlay portfolio, designed to mitigate losses in down markets, to fall. Therefore, ATSX’s 3.2% monthly gain lagged the TSX 60’s 4.8% total return.
Have questions about Accelerate’s investment strategies? Book a call with me.
Disclaimer: This distribution does not constitute investment, legal or tax advice. Data provided in this distribution should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information in this distribution is based on current market conditions and may fluctuate and change in the future. No representation or warranty, expressed or implied, is made on behalf of Accelerate Financial Technologies Inc. (“Accelerate”) as to the accuracy or completeness of the information contained herein. Accelerate does not accept any liability for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on all or any part of this research and any liability is expressly disclaimed. Past performance is not indicative of future results. Visit www.AccelerateShares.com for more information.