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UBS experts share their insights Inflation

Whether capital is invested or not – and regardless of how it is invested – there is no escaping the effects of inflation, for rising prices erode the purchasing power of any investment – by the rate of inflation. What is still contested, however, is just how investors can protect their portfolio against inflationary trends.

One reason for this is that an accurate prediction of future inflation trends is virtually impossible since, besides linear inflation, prices are also affected by, for example, unexpected political, economic and other events. It follows that inflation forecasts that take into account only linear inflation from past trends are not a very sound basis for effective, inflation-oriented portfolio rebalancing. In addition, inflation is more difficult to gauge than appears at first glance because the outcome depends very much on what goods are included in the inflation measure.

Good past performance is often not enough

One possible solution would be to find investments that performed well during past inflationary periods. However, the problem remains the same: A good performance in the past is no guarantee of a good performance in the future.

How to protect a portfolio against inflation

Summarizing the points made above, the best protection against the inflationary erosion of investment returns appears to be a well-structured, balanced portfolio. Analyses of inflation trends and the behavior of returns on certain investments during past inflationary periods can provide clues regarding allocation. However, it is important to avoid a disproportionate increase in portfolio risk.

A portfolio compiled on the basis of these considerations could include, for example, broadly diversified equity indices, baskets of commodities and inflation-linked components. Thanks to their broad diversification and high liquidity, ETFs can be a solution to help investors implement such a portfolio concept.