Let's 'Simplify' Inflation-Beating ETFs -- One Is 'Wicked Smaht'!

Inflation, inflation, inflation -- it's everywhere and surprisingly, at least to certain government officials, not transient.

Who knew?

The question for investors is how do they manage through not just inflation, but the "medicine" that the Fed is currently administering to battle it? Honestly, this regime of increasing interest rates to make the economy an inhospitable environment for inflation reminds me of the aggressive radiation and chemotherapy treatments of yesteryear which did kill cancer cells but also did a lot of damage to healthy tissue along the way. With a reminder that "winning" in investing has often been described as relative, let's take a look at some of what I would call traditional funds that are positioned as inflation fighters, or at least funds that look to give exposure to companies that benefit from higher prices and compare them to some funds that take a more advanced approach to take advantage of the high inflationary and interest rate environment we're in now.

'Old School' Inflation Beaters

The two "traditional" funds I'll look at are the Fidelity Stocks for Inflation ETF (FCPI)  and the Horizon Kinetics Inflation Beneficiaries ETF (INFL) . As you can tell from year-to-date returns through Tuesday in the table below, and with a nod to Sesame Street, "one of these things is not like the other."

Both funds are long only equity strategies, but that is where the approaches start to diverge. While my previous article pointed out that position weightings can play into fund outperformance differences, security selection can be even more impactful.

Source: All You Can ETF

Year-to-date returns of FCPI seemed closer to broad market returns, so I compared current holdings (100 securities) to both the iShares S&P 100 ETF (OEF)  and the SPDR S&P 500 ETF Trust (SPY)  and found that it shares 27 names with OEF and 76 names with SPY. Further, the fund seems to take a very broad view of companies best positioned to weather an inflationary environment with energy (Marathon Oil   (MRO) , National Fuel Gas Co (NFG) ) and various staples names (Altria Group (MO) , Kimberly Clark (KMB) ) as well as a number of technology companies (Microsoft (MSFT) , Apple Inc (AAPL) ) and some others, like broadcasters (Fox Corp (FOX) , Liberty Global (LBTYA) ) and Signet Jewelers (SIG) . It's almost as if they should have branded this fund as the "Only the Strongest Survive" portfolio.

Looking at INFL, the issuer has some exposure to traditional inflation hedges, including Energy with Cheniere (LNG) , and Permian Basin Royalty Trust (PBT) , Basic Materials like Canadian miners Altius Minerals Corp (local ticker ALS) and Labrador Iron Ore Royalty Co (local ticker LIF) and everyone's favorite "what have you done for me lately" asset class, gold with names like Franco Nevada Corp (FNV and Osisko Gold Royalties Ltd (OR) . One departure from traditional equity based inflation hedges is an almost 18% allocation to knowledge economy and capital markets with names like Marsh & McLennan (MMC) , the Intercontinental Exchange (ICE) , and CME Group (CME) . This makes sense to me if only to capture all the commodities futures trading and other activity as investors look to trade their way to safety. In case you are wondering, the 40 name portfolio has no overlap with OEF and shares seven names with SPY, which works out to about an 18% overlap as compared to FCPI.

The New School Approach

The "new" part of what I'm calling "new school" is the adoption by some ETF issuers of what had been traditionally considered institutional strategies, like using futures or exotic Over-The-Counter (OTC) derivatives to provide exposure. The first fund in this group is one that I've written about a while ago and is the Quadratic Interest Rate & Volatility Inflation Hedge ETF (IVOL) . This fund was launched in May of 2019 and the timing was excellent, if not perfect, as it caught the beginning of what turned out to be some big moves in the rate and volatility space. As you can see from the graph of fund results below this fund has not fared well over this year and I suspect it has to do with the fact that this fund has a large allocation to Treasury Inflation Protected Securities (TIPS). TIPS have made strong inflation adjustments as new figures are released but they haven't been enough to avoid the steamroller that is the Fed's aggressive rate hike regime of 2022. Perhaps when the Fed begins to stabilize rates, we will see this and similar funds start working again but I wouldn't expect it any time soon.

Source: Factset, All You Can ETF

While IVOL has suffered this year, the other fund I want to highlight is the Simplify Interest Rate Hedge ETF (PFIX) . As you can see from the performance chart this fund lagged pretty hard since its launch on May 2021, but more than made up for lost time in 2022. I've written about Simplify before and honestly, every time I talk to them or read about what they have been working on I reach back to my days living in Boston to marvel at how "wicked smaht" these guys are. It might seem obvious to trade futures on the thing that everyone "knows" is going to go up and there are a lot of institutions that are making this trade but its only through the power of the ETF structure and foresight of this issuer that us mere investing mortals can easily access this trade. Again, referencing the returns chart, this strategy is not for the faint of heart as I've calculated the realized volatility of PFIX from launch to September 20 at 45.77% which is just a double on SPYs 23.32% over the same period. Year to date volatility clocks in at 57.20% vs 28.80% for SPY as of September 20 in case you're wondering.

My Take

Given that the rate hike horse isn't entirely out of the barn, there still may be some legs to the trade exposure provided by PFIX. Reading the chart makes it look like there is some resistance at these levels and I'd be putting this on a watchlist at least. I would say that using a fund like INFL to get some broad equity market relative advantage with a side order of PFIX might be something worth taking a closer look at.

At the time of publication, Abssy had no position in any security mentioned.