Inflation-Sensitive Assets

Stefania Perrucci

In this chapter, we discuss how inflation should be analysed and managed as a key portfolio risk. We also discuss the birth of a new asset class, composed of inflation sensitive assets, that has now gained explicit stand-alone classification and allocation by several large institutional investors, including pension funds and insurance companies.

The first section introduces the concept of inflation risk. We then analyse some macro issues affecting inflation and asset prices. This provides a natural introduction to why inflation-sensitive assets, and not just inflation-linked products, should be viewed as a separate asset class and should receive consideration in any diversified investment strategy.

INFLATION RISK AND EVALUATING INVESTMENTS IN REAL SPACE

Although most commonly used investment metrics measure nominal risk and returns, a more rational approach calls for evaluating investments on a real, ie, inflation-adjusted, basis, as investors should be concerned about preserving or, even better, increasing their purchasing power.

This is not an academic distinction, but a very consequential one. In fact, historic episodes, for example, stagflation in the 1970s and the

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