FNV:CC - INFL: Consider A Lower Cost Approach To Bet On Inflation

2023-10-27 12:29:16 ET

Summary

• Horizon Kinetics Inflation Beneficiaries ETF seeks long-term growth of capital in real terms and has outperformed the S&P 500 since its launch.
• INFL charges a high management fee of 0.85%, compared to the average equity ETF expense ratio of 0.16%.
• Investors can consider building their own inflation beneficiaries portfolio using ETFs and blue chip stocks to avoid the high management fee and potentially achieve better results.

ETF Overview

The Horizon Kinetics Inflation Beneficiaries ETF ( INFL ) is an actively managed ETF that seeks long-term growth of capital in real (inflation-adjusted terms). INFL invests in companies that are expected to benefit from rising inflation.

INFL has ~$811 million in assets and charges an expense ratio of 0.85%. The fund is fairly concentrated and typically holds 20 to 60 individual securities.

Historical Performance

INFL launched in January 2021 and has outperformed the S&P 500 thus far. Since inception, INFL has delivered a total return of 23.3% compared to a 14.8% return generated by the S&P 500. This represents significant outperformance and suggests this ETF has done a very good job of meeting its objective.

High Management Fee

INFL charges a relatively high management fee of 0.85%. To put that into context, the average expense ratio for an actively managed equity mutual fund is ~0.66% and the average equity ETF expense ratio is ~0.16%. Comparably, other ETFs that benefit from inflation such as the Energy Select Sector SPDR Fund ( XLE ) and the SPDR S&P Metals & Mining ETF charge fees of just 0.10% and 0.35% respectively. As an investor, I work diligently to avoid high management fees (active or passive) as I believe they are often an overlooked headwind when investing.

Holdings Analysis

As shown by the table below, INFL is fairly diversified with no single holding making up more than 7% of the fund. The most significant exposure of the fund is to the energy sector which makes up ~28.6% of total exposure.

Another important thing to note regarding INFL holdings is the focus on royalty companies across different sectors. This makes sense as royalty companies are generally a clear beneficiary of higher inflation as their costs do not rise much while revenues generally rise with inflation.

INFL also has a large percentage of its holdings dedicated to exchange companies. This exposure makes sense given exchanges are well positioned to benefit from inflation as revenues increase with trading volume.

Perhaps the biggest surprise to me is that INFL has only ~1.5% exposure to traditional real estate investments. This is somewhat surprising to me as I would expect real estate to be a larger part of an inflation driven portfolio. However, that active decision has paid off for INFL as real estate has significantly underperformed energy and mining.

An Alternative Approach to Consider

Investors looking to benefit from inflation can use INFL as a guide to build their own inflation beneficiaries portfolio and avoid paying the 0.85% annual management fee. Below is a potential inflation beneficiary model portfolio made up of ETFs and blue chip stocks that I believe is preferable to INFL:

XLE: 27.2%.

- XLE charges a management fee of 0.10% and represents a highly cost effective way to get exposure to energy.

CME Group ( CME ): 8%.

Intercontinental Exchange ( ICE ): 8%.

- CME and ICE are both high quality exchanges held by INFL. I have scaled them up to represent the entire exchange allocation in INFL.

Visa ( V ): 18%.

- V benefits from inflation as total card spend increases faster than expenses. I recently discussed this in my article Visa Reports Strong Q4 FY 2023 Earnings: Initiating A Strong Buy .

Wheaton Precious Metals Corp. ( WPM ): 6.2%.

Franco-Nevada Corporation ( FNV ): 6.2%.

- Both WPM and FNV are large holdings in INFL and I agree they represent an excellent way to gain precious metals exposure.

XME: 10.4%.

- XME charges a management fee of just 0.35% and represents a cost effective way to get diversified exposure to the mining sector.

Deere & Company ( DE ): 11%.

- DE represents an attractive way to participate in any agriculture price upside. DE has a strong history of being able to deliver attractive returns.

Vanguard Real Estate Index Fund ETF Shares ( VNQ ): 5%.

- VNQ charges a management fee just 0.12% and represents a highly cost effective way to get exposure to U.S. real estate.

Key Differences in Model Portfolio vs. INFL

The model portfolio gets exposure to energy via XLE while INFL gets energy exposure mostly through royalty companies. I prefer XLE as it better allows investors to manage taxes as distributions are generally smaller than royalty companies. Royalty income is generally taxed as ordinary income where as dividends from XLF generally will be treated as qualified dividends which allows them to qualify for a lower tax rate.

The model portfolio has a concentrated position 16% in CME to express the exchanges portion of the portfolio. I believe CME is a best in class operators and prefer to own this vs. the basket of exchanges owned by INFL.

The model portfolio add an 18% position in V. I believe V is very attractive investment at current levels and a position that can do especially well in an inflationary environment will still delivering strong returns if inflation moderates from here.

The model portfolio gets exposure to the agriculture sector via DE as opposed to traditional agriculture producers such as Archer-Daniels-Midland Company ( ADM ) or Bunge Limited ( BG ). Over the long-term, as shown by the chart below, DE has significantly outperformed both ADM and BG. I expect this to continue in the future as DE has a more differentiated business model.

The model portfolio has a 5% weighting in real estate, expressed via VNQ, as opposed to 1.5% in INFL. Real estate stocks have sold off significantly of late and I believe real estate exposure represents an attractive investment at current levels.

Since INFL launched, and assuming no rebalancing, the model portfolio would have returned 45.3% compared to 23.33% for INFL.

Conclusion

INFL is in innovative product and has done a solid job of meeting its objective to provide exposure to companies that benefit from rising inflation. INFL has been able to outperform the S&P 500 since inception.

That said, INFL charges a very high management fee of 0.85% and I believe investors can use INFL as inspiration build a superior inflation beneficiary portfolio that avoids the high 0.85% management fee and builds a portfolio that has a chance to also deliver strong results even if inflation cools.

The model portfolio I constructed significantly outperformed INFL since inception and I expect it to do so in the future.

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