Hi guys, Study Session 12 states that equities have offered a positive real return over the past 100 years and are therefore a good inflation hedge. Study Session 13 suggests that alternatives are a strong inflation hedge whereas bonds/stocks are a poor inflation hedge. Study Session 6 (i think) suggests that as companies are not able to pass price increases onto the company, equities fall during periods of high inflation. These are clearly convicting messages, am I missing something here?
you have to look at each asset category in isolation you cannot generalize particular asset class for example 1)storable commodities are good inflation hedge whereas perishables are not. 2)For equities it depends which companies can pass inflation to consumer ( inflation flow thru rate from L2) 3)In FI Tips are inflation protected but not other treasuries. you can further classify whether Coupon or principal is inflation protected . For ex floating rate coupon is inflation safe but principal is not I hope this explain a bit
Agree with captain and see your point as well…in general, equities should be a decent inflation hedge but all depends on pass through of inflation which for many companies does not happen (elastic demand)
If I were given the question: Explain whether equities are an inflation hedge, I would answer with something similar to “Equities are mostly not a decent inflation hedge as most companies operate within elastic demand industries and are not able to pass on price increases to customers. As a result, most equities fall during high periods of high inflation” The CFA definitely contradicts itself here and although its fine looking at study sessions in isolation, I thought the whole point of Level 3 was to bring multiple study sessions into an item/essay set. How would you guys answer: Explain whether equities are an inflation hedge?
Be careful here. I’m pretty sure The Equity section discusses inflation in terms of emerging markets exposure. The Alternative Investment section discusses use of derivatives & more direct inflation hedges. So the one thing I would add to The Capt’n’s correct answer is that the objective should be considered, too.
Nice explanation Captain Barbosa…
I think it also depends on the horizon you are looking at. For example, if inflation is expected to be high, cash instruments could be a good investment because most likely the central bank will increase interest rate to curb inflation rate. In that case, cash instrument offers a better return than FI or equity. As Captain Barbosa pointed out, equity could have negative return in high inflation environment. But over the long run, equity offers growth that neither bond nor cash instrument could possibly offer.
Thanks guys - this has cleared it up.