Abstract

This article proposes a method to construct inflation-friendly equity strategies that offer protection against inflation surprises. Such strategies offer stronger and more consistent inflation exposures than commonly used off-the-shelf ingredients, such as sector or style factor portfolios. We rely on firm-level measures of inflation exposures that improve robustness when compared with standard estimation approaches. We show how to construct these inflation-friendly equity strategies and how they can be designed as a replacement of cap-weighted benchmarks in long-term strategic allocations or for tactical allocations. Furthermore, we illustrate the benefits of such strategies for investors, presenting two concrete investment cases.

Scientific Portfolio AI- Generated Summary

The paper “Inflation-Friendly Equity Indices: How to Protect against Rising Inflation in Equity Portfolios?” by Daniel Aguet and Dimitris Korovilas presents strategies to protect equity portfolios from the erosive effects of inflation. The authors analyze historical data to identify sectors that tend to perform better in inflationary environments, such as energy, utilities, and materials, which have pricing power and can absorb rising costs. By over-weighting such sectors, investors may help offset inflation risks.

Aguet and Korovilas also emphasize a factor-based approach, focusing on value and quality stocks. Value stocks, often priced below their intrinsic value, can provide resilience as they are less vulnerable to inflation-driven volatility compared to high-growth stocks. Quality stocks with strong balance sheets and consistent profitability also tend to outperform during inflationary periods due to their financial stability. The authors highlight that combining these factors can add another layer of protection to portfolios, reducing exposure to inflation-sensitive downturns.

Additionally, the paper discusses using inflation-linked instruments, such as Treasury Inflation-Protected Securities (TIPS), within equity portfolios to counterbalance inflation shocks. These securities adjust with inflation, providing a steady hedge.

The authors conclude by recommending an approach that blends sector allocation adjustments with factor strategies and inflation-linked assets to build inflation-robust equity portfolios. This diversified method is designed to help protect purchasing power during periods of sustained inflation, aligning with a long-term, inflation-conscious investment strategy.