Vanguard: Commodities Can Offer Outsize Inflation Hedge

What You Need to Know

  • Inflation-sensitive assets such as commodities and TIPS can provide some protection to investors with a shorter time horizon.
  • TIPS can also provide some protection but offer a more limited hedge.
  • According to the Vanguard paper, commodities are about the present, while equity and fixed income are indicative of the future.

Incorporating commodities into portfolios can provide outsize protection against unexpected inflation as well as diversification benefits, new research from Vanguard suggests.

“Commodities tend to behave differently than traditional asset classes, especially when commodity price shocks are driven by unexpected changes in supply,” Vanguard noted in a  recent post based on the paper, “Commodity Investing and Its Role in a Portfolio.”

Over the past three decades, commodities’ inflation beta — or their sensitivity to inflation — has fluctuated between 6 and 9, the highest among all the asset classes analyzed in the study, according to Vanguard.

“This suggests that a 1% rise in unexpected inflation would produce a 6% to 9% rise in commodities,” the paper’s authors concluded. “In short, a small yet strategic commodity position can offer an outsized safeguard for an overall portfolio.”

While markets expect some inflation, unexpected inflation caused by supply disruptions — such as those caused by China’s extended, COVID-related factory shutdown and Russia’s attack on Ukraine — can prove particularly damaging for retirees and others with short time horizons, the authors noted.

Inflation-sensitive assets such as commodities and Treasury inflation-protected securities (TIPS) can provide some protection, according to the paper.

“Investors with a longer time horizon may fare well with equities as an inflation-fighting tool, but people who are concerned about purchasing power over the next five years may want to consider a strategic exposure to commodities futures,” one of the study’s authors, Fei Xu, Vanguard Quantitative Equity Group head of alternative and multi-asset investments, said in the post.

“Commodities prices in general trend upward as the cost of consumer-driven commodities like food and gas rise, which can lead to higher unexpected inflation,” he added.