Inflation panic gripped investors again last week, sending fast-recovering equity indices into reverse as US consumer prices jumped at their fastest rate since 2008.

Data from the US Labor Department revealed inflation rose 4.2% in the 12 months through April, up from 2.6% the month before. 

This comes amid supply shortages in electrical components, agricultural produce and industrial metals, which have had an acute effect on manufacturing and seen the price of second-hand vehicles shoot up 10% in April alone.

These forces have also brought the monetary tightening conversation back to the fore, with investors anticipating sooner-than-forecast interest rate hikes to prevent economies such as the US from overheating.

None of this is particularly surprising. Even though US 10-year Treasury yields rose on Wednesday’s inflation announcement, they did not reach an all-time high, suggesting an overshoot was largely priced-in when the discussion had been raised on several occasions over the preceding months.

Inflation: The biggest risk facing investors over the next year

Despite this, equity investors were not as resolute. The S&P 500 dropped 4% between its high and low points on Monday and Wednesday, meanwhile the Nasdaq shed 4.8% during the same period as frothy tech valuations lost some ground.

More interestingly, the FTSE 100 fell 4.3% between Monday and Thursday, reflecting the potential impact of rates increases on the pace of recovery currently being enjoyed by COVID-19-hampered cyclical equities. 

With tension between a strong bounce back and monetary tightening likely to be the main talking points through 2021, ETF Stream has selected five ETFs to help investors ride out the inflationary storm.

1. Invesco Bloomberg Commodity UCITS ETF (CMOD)

Topping our list is the $1.1bn Invesco Bloomberg Commodities UCITS ETF (CMOD) which replicates the movements in commodities futures prices. 

With material inputs to fuel economic recoveries around the world in high demand, supply bottlenecks in energy, agriculture and metals have seen the prices of CMOD’s underlying index constituents boom in recent months.  

Agriculture ETCs boom amid supply-demand pinch

The economic recovery hinges on the continued supply of these commodities. In this sense, CMOD broadly tracks economic activity and output, which are both expected to continue rising as restrictions ease. Likewise, consumer prices are also heavily influenced by input costs, so as inflation indicators rise, this likely reflects higher returns are being enjoyed by commodities investors. 

The product is 32% weighted to energy and 24.2% to grains, both of which are currently in backwardation. It also has a 15.5% weighting to precious metals, which are a natural hedge against inflation, and a 15.2% weighting to industrial metals, both crucial to the ongoing recovery and the secular shift to clean energy.

2. Xtrackers MSCI World Financials UCITS ETF (XDWF)

For investors seeking exposure to the cyclicals recovery, the $1.2bn Xtrackers MSCI World Financials UCITS ETF (XDWF) tracks the performance of 231 large and medium-cap financial service providers across the world.

XDWF has been a strong favourite among European ETF investors so far this year and some might be concerned a lot of the financials bounce back has already played out. Indeed, US banks make up more than half of the ETF’s basket and seven of its top ten holdings are US banks that enjoyed price recoveries between 10-15% in the first two weeks of February alone.

However, XDWF’s global focus means it has exposure to banks in other regions, such as European banks which recently published strong Q1 performance data.

Investors pile over $1bn into European financial ETFs in one week

Furthermore, from an inflation point of view, banks will welcome the renormalisation of interest rates. While it is reasonable to assume rates hikes will have some negative effect on borrowing activity, business loans and mortgages are an inevitable component of any economic recovery – and increasing the cost of capital will ultimately mean stronger bottom lines for banks, insurance companies and brokerages.

3. Tabula US Enhanced Inflation UCITS ETF (TINF)

For those looking for fixed income plays, the $58m Tabula US Enhanced Inflation UCITS ETF (TINF) replicates the Bloomberg Barclays Enhanced Inflation Index, combining the performance of Treasury inflation-protected securities (TIPS) and US 7-10 year breakeven inflation rates. 

The first ETF in Europe to combine these two features on a US Treasuries exposure, TINF launched in November 2020 and combines current TIPS performance with forward-looking inflation expectations.

With central banks reluctant to either shut off their asset buying programmes or bring forward their rates hikes, TINF and more run-of-the-mill inflation-linked products offer a way for bond investors to protect their returns.

4. iShares Physical Gold ETC (SGLN)

Investors looking for orthodox inflation hedges might consider the $13.8bn iShares Physical Gold ETC (SGLN), the largest ETF in Europe physically replicating the price performance of gold bullion.

One of the traditional safe havens against shifts in currencies’ purchasing power, gold shelters investors from inflationary events such as a weakening dollar and a rising consumer price index.

As the US dollar fell in the decade up to 2008, the price of gold almost tripled. Likewise, amid quantitative easing following the 2008 crash, gold doubled in value in the four years to 2012. Having fallen from its highs in 2020, the return of inflationary concerns has seen the price of gold rally 9.2% in the six weeks to 14 May, a trend that will only continue if policymakers allow inflation to run further.

SGLN is one of four products available in Europe offering the joint-lowest fee of 0.15%, the others are the Ridgex GPF Physical Gold ETC (TAUS), the Invesco Physical Gold ETC (SGLP) and the WisdomTree Core Physical Gold ETP (WGLD). SGLN is suggested because its size implies strong liquidity and a developed trading infrastructure.

5. iShares UK Property UCITS ETF (IUKP)

For a more wildcard inflation hedge, investors might consider the $687m iShares UK Property UCITS ETF (IUKP), which tracks the performance of equities on the FTSE EPRA/NAREIT UK Property index. 

The economic recovery has seen demand for residential property soar across the developed world, with the FTSE EPRA/NAREIT developed index shooting up 21.5% in the six months to 30 April. Further economic reopening will facilitate easier travel, construction activity, supply chain continuity and even property viewings – not to mention the return to normal may offer the necessary reassurance needed for buyers and letters holding out during pandemic volatility. 

Offering a regionally targeted exposure to this line of thinking, IUKP is UK-focused. Benefitting from an extension of the UK government’s Stamp Duty relief, low deposit and first time-buyer loan schemes, the ETF returned 9.5% in the three months to May 13. 

Something to note is the ETF’s high conviction position in Segro, which currently claims a 19.3% weighting. Primarily operating industrial premises and warehouses, investors might look to back the company as both a direct property play – with house price inflation pushing up rental revenues – and as a recovery exposure, with the return to work and pick-up in consumer activity likely to increase commercial leasing activity in UK and European cities.

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