The mutual fund that is beating the market: a look inside | Jobs Vox


In the past year, inflation has taken a toll on Americans’ budgets and portfolios. The average price of a basket of consumer goods rose 8.3% in the 12 months ended in August, with some categories, such as food and gasoline, rising even faster, according to the Bureau of Labor Statistics.

When the Federal Reserve began a series of interest rate hikes to cool inflation, investors had nowhere to hide. Bond prices, which move in the opposite direction of interest rates, fell 12 percent in the year ending in August. And the stock market fell nearly 16 percent over the same period as investors worried that the Fed’s actions could lead to a slowdown in the economy.

If you park your money in cash, you’re not doing all that good, says Ford O’Neill, associate portfolio manager at Fidelity Strategic Real Return Fund, a mutual fund strategy focused on protecting investors from inflation risk. “Even if you feel safe in a money market account and the rate doesn’t change, I can assure you that the rate of inflation is much lower than what you’ve experienced,” he says. “You actually have a negative real return.”

The fund that O’Neill helps run is focused on delivering returns that exceed the rate of inflation over a 3- to 5-year period. Given today’s high inflation, it’s no coincidence that its 2.7% 1-year return through August dwarfs the negative double-digit returns of stocks and bonds.

The details of this fund can help professional investors think about how to go about combating inflation, as well as how to manage risk in your own portfolio strategy. See what’s inside.

The assets of this fund are designed to protect investors against inflation.

To determine which assets perform best in a fund that seeks to outpace inflation, O’Neill and his colleagues examine the long-term 12-month returns of various investments — a measure analysts use to see how consistently an investment performs — how often it outperforms the consumer price index.

The following four asset classes hold prominent positions in the fund and have a historical track record of above-average inflation. The percentage next to each shows how much the property held for inflation from December 1973 to June 2022, based on absolute returns, according to data from Fidelity.

  • Floating Debt (80%): Also known as “bank loans”, these are (usually low-quality) loans from banks to companies. The interest rate on this debt is generally tied to a short-term rate that resets every 30 to 90 days. This means that these bonds tend to hold their value when interest rates rise. In other words, when central banks raise rates to cool an inflationary economy, these bonds benefit.
  • Tips (75%): As the name suggests, Treasury inflation-protected securities are designed to protect bond investors against inflation. Like Treasurys, these bonds are issued and backed by the US government, but with an added wrinkle: the bond’s principal value adjusts for inflation. The price of TPS revolves around the “break rate,” or the difference between the TPS and Treasurys held on the same date. 5-year TIPS will outperform 5-year Treasuries over the next five years if the current 5-year 2.33% inflation rate averages 2.33%.
  • Real Estate Shares (70%): “If you think about the elements that make up the CPI, the biggest part is housing,” O’Neill says. Real estate investment trusts — which own income-producing real estate or shares in companies — tend to keep pace with inflation because they like inflation. Companies that offer long-term leases generally build inflation into their contracts, and short-term landlords can increase rents when home prices rise.
  • Commodities (59%): Look at the list of categories listed in the CPI, and you’ll see commodities everywhere, O’Neill pointed out. “Inventories are included in the CPI,” he says. “Think about utilities, fuel, heating oil. Airline ticket prices are based on jet fuel prices.”

Track records are mixed among the assets the fund holds to beat inflation, and that’s the point. By building investment portfolios that don’t move in lockstep, managers are spreading their bets knowing that each performance will ebb and flow in different market conditions.

“Commodities had a challenging time following the global financial crisis, but they have more than recovered over the past three years,” says O’Neill. “Real estate has bounced back from March 2020 lows, but on a 1-year basis, real estate is now in good shape.”

Over the long term, this well-differentiated approach has proven to be greater than the sum of its parts. From December 1973 to June 2022, an asset mix similar to Strategic Real Return beat inflation by 80%.

When hedging inflation — as is the case with any investment risk — you’re better off casting a wide net rather than picking one investment that you think might be the silver bullet, O’Neill says.

“You never know when things are going to work out. You have to give yourself a lot of chances to win.”

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