Core-Satellite Approach to Hedging Inflation

This technical report discusses the core-satellite approach to managing inflation risk in investment portfolios. It outlines the renewed focus on inflation risk due to recent volatility in commodity markets and geopolitical tensions, which have raised concerns about potential inflation pressures. The report emphasizes that while long-term purchasing power is best preserved through growth assets like equities, inflation-sensitive assets such as commodities and Treasury Inflation-Protected Securities (TIPS) can enhance short-term inflation protection. The core-satellite strategy involves making modest allocations to these inflation-sensitive assets, which can improve a portfolio's inflation beta while maintaining diversification and long-term return efficiency. The report also examines how different asset classes are expected to behave over 10- and 30-year periods, using the Vanguard Capital Markets Model (VCMM) to assess their effectiveness in keeping pace with inflation. It highlights the trade-offs involved in enhancing inflation protection, including increased portfolio volatility and potential underperformance.