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While some inflation indicators suggest pent-up demand could drive inflation and interest rates to unmanageable levels, other forecasts indicate current high prices are one-offs and growth will soon return to its tame pace as supply chains return to normal.

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There’s an old joke in finance that goes if you put five economists in a room they will come out with six different forecasts. It’s particularly apt right now as economists try to get a fix on a global economy emerging from an unprecedented pandemic in which economic activity has resumed in fits and starts.

The joke isn’t so funny for financial advisors left with the challenge of having to prevent clients from having their investment returns swallowed up by inflation.

Year-over-year inflation indicators, normally considered reliable, suggest pent-up demand could drive inflation and interest rates to unmanageable levels. Other forecasts indicate abnormally high prices for items like food and building materials are merely one-offs and growth will soon return to its tame pace as supply chains return to normal.

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“So much of it is just psychological and that’s what’s so hard to predict – even for the experts who are supposed to have a handle on this stuff,” says Ben Carlson, director of institutional asset management at U.S.-based Ritholtz Wealth Management LLC.

The uncertainty leaves money managers like Mr. Carlson with the task of establishing hedges in client portfolios to keep returns outpacing inflation – whether it comes or not. Taking all the data and expert forecasts into account, he’s decided the best course of action is to stay the course.

“We found using a macro framework to continually churn a portfolio and change it around is fruitless because it’s really hard to do. Being diversified is probably the simplest answer for most people,” he says.

“It’s about preparing for a range of outcomes and having different asset classes and different strategies that you are going to be willing to hold no matter what the economic environment,” says Mr. Carlson, who insists investors who need their portfolios to grow to meet their retirement goals must remain invested.

“The simplest hedge against inflation has always been the stock market because earnings and dividends both have shown to be very good hedges against inflation over the long term,” he says.

Mr. Carlson says diversification also means maintaining a portion of a portfolio in fixed income to offset the risk from the equities portion. That’s a hard sell considering safe, fixed income products like guaranteed investment certificates and government bonds often pay yields below inflation. However, he says keeping fixed income maturities for short durations is a good hedge against inflation because bond yields tend to rise with inflation.

“Even though it’s a poor hedge over the long term it’s a better hedge over the short term because it allows you to reinvest your cash flows at higher rates, quicker,” he says.

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For Craig Machel, portfolio manager and investment advisor at Toronto-based Richardson Wealth Ltd., inflation is just one portfolio risk he attempts to neutralize. His “market neutral” investment style creates portfolios that generate consistent returns regardless of market or economic conditions.

“We have a lot of strategies in our diversified portfolios that will continue to make money whether there is inflation or disinflation or stagflation, or whatever,” he says. “We’re always owning assets that are inflation hedged.”

Mr. Machel’s “pension fund style” strategies vary, but include generating reliable income streams from private real estate and private mortgages in high-growth regions in the U.S. like Texas and Florida. He says income from variable or short-term mortgages and apartment yields, and capital gains from real estate, tend to rise with inflation, creating a natural hedge.

“In a rising interest rate environment, in a fixed rate mortgage fund, you always have something that’s going to trend back tomorrow or the next day at a higher rate,” Mr. Machel says.

His market-neutral portfolios generally target real returns of between 4 per cent and 5 per cent. While he feels confident he can maintain those targets regardless of inflation, he also believes they can withstand any volatility that comes with it.

“Volatility can play in your favour as long as you have strategies that are agile and nimble,” he says.

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If the market volatility that could come with inflation is too much for the risk-averse investor, there are always annuities.

Simon Kay, president of Toronto-based IPS Insurance, recommends annuities as an alternative to fixed income in a retirement portfolio because they can be tailored to an individual’s risk tolerance, return expectations and life expectancy.

“We start with what you need, include inflation in that estimate, then backdrop what an annuity would be to cover that monthly income that you require,” he says.

Annuities also can be set up to tie payouts to inflation gauges like the consumer price index (CPI), but Mr. Kay says they don’t always reflect individual circumstances.

“The inflation index, which is a bundle of all goods and services, is not necessarily a reflection of what an individual’s specific lifestyle inflation would look like,” he says.

Of course, safety has its price. Annuity holders pay higher fees for the luxury of offloading risk, and the fees get bigger as the risk gets smaller. Mr. Kay says annuities are designed for people who place a high value on security.

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“What’s the value of not worrying about whether your pot of money is going to run out?”

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