Perhaps even more noteworthy is the volatility of these assets over this inflation ramp-up period, which ensured opportunities for tactical shifts in these assets. As evidenced in Table 3, there were ample opportunities to capture significant real returns in the shorter time periods. For example, REITs earned real returns of +12% in 1977, -11% in 1978, +17% in 1979, and -7% in the first four months of 1980. We see similar variations in the other asset classes. A tactical exposure to a broader set of asset classes provides an opportunity to add value over the static exposure to the traditional asset classes over this time period.

Summary

Inflation is the largest single enemy to long-term investors. The goods and services we purchase in retirement will be priced in tomorrow’s dollars, not today’s. Rapid acceleration in inflation—reflation—dramatically impacts mainstream bonds and, to a lesser extent, stocks. Thus, investors are wise to include dedicated real return exposures in their portfolios. But the devil is in the details. Those that narrowly concentrate on static real asset exposures are fighting rising prices with one hand tied behind their back. To deliver the knockout, inflation fighters need a combination of an expanded tool kit and disciplined tactical exposure management.

Endnote

1. Part of this lies with foreign currency exposure. EAFE outperformed the local currency variant by 8% per annum above, indicating that exposure to foreign currencies is just as important in a real return portfolio. (Calculated as the difference between the EAFE Gross Total Return and the EAFE Local Currency Total Return based on data from Morningstar Encorr.)

© Research Affiliates®, LLC 2009. The material contained in this newsletter is for information purposes only. This material is not intended as an offer or solicitation for the purchase or sale of any security or financial instrument, nor is it advice or a recommendation to enter into any securities transaction. The information contained herein should not be construed as financial or investment advice on any subject matter. Neither Robert D. Arnott nor Research Affiliates and its related entities warrants the accuracy of the information provided herein, either expressed or implied, for any particular purpose. Nothing contained in this newsletter is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this newsletter should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.

ROBERT ARNOTT, Chairman and Founder of Research Affiliates, LLC.

JOHN WEST, CFA, Director, Product Specialist of Research Affiliates, LLC.

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