One of the many risks investors have to deal with, especially bond investors, is inflation risk. PIMCO has a paper out entitled “A Diversified Real Asset Approach for Managing Future Inflation Risk” that is worth reading. They discuss one way of dealing with inflation through using real assets, the most liquid of which are:
… inflation-linked bonds (including Treasury Inflation-Protected Securities, or TIPS), commodities, real estate investment trusts (REITs) and commodity-related equities.
As a benchmark, the authors suggest a one-third weighting to each of these asset classes, with the exception of commodity-related equities, which they believe are inferior to direct commodities in terms of reducing direct equity risk.
The authors also endorse tactical asset allocation:
This “one-third, one-third, one third” benchmark is also a good starting point for actively managing the mix of asset classes, which can be an important tool for enhancing the overall effectiveness of the diversified real asset strategy.
As the drivers of future inflation risk naturally evolve, relative attractiveness across these three real asset classes will change, since they each respond differently to different inflation drivers. A rigorous asset allocation methodology that can identify macroeconomic and sector-specific risks and opportunities may add value for investors by tilting the real asset mix around the static benchmark weights.
Systematic relative strength provides just such a rigorous approach. It should be a comfort to know that all of these asset classes used to manage inflation risk are included in the investment universe of our global tactical allocation products, such as the Global Macro separate account, the Arrow DWA Balanced Fund, and the Arrow DWA Tactical Fund. The investment universe of those products, however, does not stop at inflation hedges. They are also fully capable of adapting to environments with a strong equity focus, whether domestic or international, or a strong defensive focus, where cash, short-term bonds, or inverse positions (Global Macro and Arrow DWA Tactical Fund) might be in vogue. Whether the world economy faces deflation or inflation in the future, flexible allocation across a broad universe should allow a rigorous tactical process to adapt.
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