Inflation has always been a concern for investors, and with recent economic uncertainties, finding investment opportunities that can withstand a challenging macro backdrop is crucial. To learn about an actively managed exchange-traded fund (ETF) that is designed to provide positive real investment returns in an inflationary environment, Wealth Advisor Managing Editor Scott Martin tapped James Davolos, a Portfolio Manager at Horizon Kinetics, to discuss the Inflation Beneficiaries ETF (NYSE: INFL).
Davolos explains how INFL aims to provide long-term compounding returns by investing in cyclical industries and businesses that can outperform inflation while minimizing risk exposure. Unlike Treasury inflation-protected securities (TIPS), INFL aims to earn a minimum equity risk premium above and beyond inflation.
The fund’s focus is on high-quality equities of businesses with capital-light models. These companies have high operating margins, minimal balance sheet intensity, and scalability, making them resilient in the face of rising costs. These businesses can generate sustainable cash flow and attractive valuations by benefiting from revenue and price without significant exposure to expenses and reinvestment.
Davolos also notes that the companies INFL invests in become more defensive thanks to their capital-light business models. This defensiveness acts as a bulwark, driving capital into these companies. Additionally, the INFL companies have sustainable competitive advantages, high cash flow generation, and attractive valuations.
Although the fund provides exposure to sectors such as energy, metals, land, agriculture, and infrastructure, it focuses on niche businesses within these sectors rather than mega-cap names sparsely populated in the index. This approach underpins the fund’s core holding potential in an investor’s portfolio, offering exposure to essential sectors through a meticulously curated selection of companies.
The investment process for INFL is labor-intensive and relies heavily on good old-fashioned research, Davolos says. The companies are not easily screenable for inclusion or exclusion, requiring a deep understanding of each business and its true sustainable cash flow generation.
The team at Horizon Kinetics conducts extensive due diligence, digging through various sources to identify companies with strong fundamentals and growth potential. This process allows them to uncover hidden gems while avoiding potential time bombs. This hands-on approach to portfolio construction enables them to avoid overcrowded names and discover untapped value.
Davolos emphasizes the importance of active management in today’s market, where many managers fear underperforming the benchmark and crowd into the same names. INFL stands out with an active share of more than 90%, indicating a high level of differentiation from the benchmark. This differentiation is a byproduct of Horizon Kinetics’ rigorous research process and commitment to finding unique investment opportunities that can outperform inflation.
Looking ahead, Davolos believes that the Federal Reserve’s recent acknowledgment of not reaching the 2% inflation target before cutting rates suggests it is prioritizing employment and financial stability over inflation control. If inflation “is the squeaky wheel,” he says, the Fed seems willing to “let it squeak.” Davolos advises that navigating the transition from a rate-hiking cycle to a lower growth rate in the global economy will be a tricky process, and only time will tell how it unfolds.
With this uncertainty in mind, advisors and broker-dealers should be aware of investment solutions that can provide long-term compounding returns while minimizing risk exposure. INFL, the Horizon Kinetics Inflation Beneficiaries ETF, offers a unique approach to investing in high-quality equities of businesses with capital-light models. By focusing on niche businesses within cyclical industries, INFL aims to outperform inflation and provide attractive valuations.
The fund’s active management approach and rigorous research process differentiate it from passive strategies, offering advisors and broker-dealers an opportunity to diversify their clients’ portfolios and potentially generate superior returns. As the market evolves, staying informed about innovative investment solutions such as INFL becomes increasingly important.
