Inflation continues to be a key theme in mutual fund firms' product development.
For instance, six fund portfolios whose names included the words "real return" were introduced in 2010, according to Morningstar Inc. This compares with two such fund start-ups in 2009, one in 2008 and none in 2007. And the inflation theme has persisted: Prudential Financial's investments unit, for example, introduced its Prudential Real Assets Fund, which aims to manage inflation and interest rate risk, in December.
Economists have been forecasting sharply rising inflation since the flood of federal stimulus spending began more than two years ago. Inflation is a serious concern for investors because it can dramatically corrode their buying power over time.
Fund companies say they are rolling out solutions now in response to investors' inflation concerns.
"A lot of our customers had come to the senior management of the firm worried about the Fed's balance sheet options and the growing deficit," said Kevin Kearns, a co-manager of Loomis, Sayles & Co.'s Multi-Asset Real Return fund, which was started Sept. 30.
Real return funds such as Kearns' seek to provide returns that keep up with inflation and then some. To create its fund, Loomis, Sayles started from scratch, researching what causes inflation, what the varieties are and how money is made or lost in times of rising prices. Based on its research, the company decided the fund should offer multiple asset classes and management flexibility.
"A lot of products out there say, 'This will protect you from inflation,' " said Kearns. "We found that there is no one silver bullet for this problem."
Loomis, Sayles ended up designing its portfolio with multiple-asset-class diversification that it says addresses everything from classic inflation to "debtflation" to "stagflation" and deflation. Single-asset-class solutions, such as Treasury Inflation-Protected Securities, or Tips, may not effectively counter more than one variety of inflation, the company argues.
The new fund may invest in a broad range of securities worldwide, including fixed-income instruments, equities, exchange-traded funds, real estate investment trusts and commodity instruments. Its managers are allowed to use derivatives and long/short strategies.
An argument can be made that actively managed funds are a better inflation hedge than Tips, according to John Jay, a senior analyst at Aite Group LLC. Tips are designed to at least keep pace with inflation — as measured by the Consumer Price Index. The problem is that the familiar core CPI figure does not include energy and food prices, which are everyday realities for people.
So although Tips can keep investors' portfolio value from falling behind the CPI, they might not keep it on pace with rising energy and food prices, said Jay. But Tips remain "definitely the cheapest" way to fight inflation, he added.
Eaton Vance Corp. is another fund company that sees limits to Tips as an inflation hedge, especially long-term Tips. The company's Short-Term Real Return fund, rolled out in March 2010, invests in two asset classes, whose returns, it says, are closely correlated with inflation: short- and intermediate-term Tips and floating-rate corporate loans.
The company has warned that today's low interest rates could hamper inflation-protected income funds that hold longer-maturity Tips as the economy recovers. The portfolio incorporates lessons learned in 2006, said co-manager Thomas Luster. Inflation then was picking up for the first time in a decade, and the economy was expanding, he said, and many Tips funds were producing negative returns. Eaton Vance tabled plans for a new inflation-hedging fund at that time but revived them with its Short-Term Real Return offering.
Judging from today's low inflation rate — the CPI showed 1.5% growth for 2010 — the flurry of new inflation-focused funds has arrived well in advance of actual inflation. At the moment, the U.S. is a world away from the galloping inflation of the 1970s.
But some of the classic warning signs of inflation are present, from inflation abroad to rising commodity prices. "Don't think about CPI but about real purchasing power," he said.
