RAAX - VanEck Inflation Allocation ETF: Still Offers Some Merit But The Core Thesis Is Diminishing

2023-04-20 18:30:29 ET

Summary

• RAAX is a fund of funds that seeks to generate real returns and reduce downside risks during market declines.
• Inflationary conditions are abating even as the risk of deflation picks up pace.
• RAAX's low sensitivity to the market and strong exposure to gold may help.

The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand, a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers. - Ben Bernanke

The VanEck Inflation Allocation ETF ( RAAX ) is an actively managed fund of funds product that pursues ETFs which provide exposure to:

1. Inflation-fighting real assets which include commodities, metals and mining equities, natural resource equities, etc.
2. Income assets which include REITs, MLPs, and infrastructure.
3. Financial assets which include gold and gold mining assets.

Is this a suitable product to pursue at this juncture? Well, here are my big-picture thoughts.

RAAX: Yes or No?

Firstly, note that over the last two years, RAAX has proven to be a useful source of alpha, outperforming the broader markets by over 4x.

Given how elevated CPI trends have been during that period, you would have expected RAAX's portfolio to fare pretty well. However, the scenario has shifted off late, and this has understandably weighed on sentiment toward RAAX. Since February this year, we've seen a sharp drop, with the current inflation rate the lowest it's been in 2 years. See how that inflation pivot has played out with RAAX returns. Since February it has been underperforming the S&P 500 on a consistent basis.

Now, if you've been following my recent commentary either via The Lead-Lag Report Twitter account or via a direct subscription to my research, you'd be well aware that I've been flagging a shift in the texture of risk from inflation to deflation.

As noted in a thread on the timeline of The Lead-Lag Report, the hub of these deflationary forces could well be the housing market. The housing supply situation has been ramping up at a steep pace (in March it was up by 60% ). This will no doubt weigh on prices and have a direct impact on the CPI number.

Meanwhile, single-family housing starts which were at around the 1.19m mark a year ago, have dropped to just 860k. We already know higher mortgage rates have been pricing out a lot of buyers and the recent banking crisis has only disrupted credit flow even more, with lending standards getting even more stringent.

Portfolio manager Victor Xing warned market participants to not rest on their laurels assuming that the banking contagion has passed. In fact, he flagged the growing risks of contagion shifting to the non-banking space, which in turn could stimulate a credit event.

A declining housing market will have a deleterious impact on consumer sentiment and spending patterns, which in turn feeds into the deflation narrative. In the 'Leaders-Laggers' section of The Lead-Lag Report, I noted how discretionary stocks are now getting impacted by a slowdown in retail sales. Earlier in the year, people were getting carried away with a solid 3% gain in January, but the reality of the situation is that we've had seven negative readings over the past 10 months.

If housing slows, you can imagine how this will filter through to the commodity space as well, and this may impact RAAX adversely as it has heavy exposure to commodity-based ETFs.

While inflationary conditions could be on the wane, RAAX may lose some of its previous luster, but even from a defensive angle, it offers some merits, and may not necessarily witness brutal drawdowns quite like the S&P 500.

To reiterate, RAAX's goal is not just to maximize real returns, but also to reduce downside risk during market declines, and it does so by gaining solid exposure to gold-related products such as pure gold, gold miners, gold strategies, etc.

However, given these diversification merits, and for gold to witness more interest, you'd need to see a larger proportion of market participants turn bearish on risk assets.

If you've followed some of the tweets I've put out in recent weeks, I have been arguing that there's a degree of complacency going around, and the probability of an accident taking place this month looks increasingly likely. Sure, there could be a slight delay to this scenario, with the markets making a potential turn higher, which ultimately coalesces into a false breakout.

However, if a breakdown comes through, it's preferable to increase exposure to low-beta options, and that's where RAAX could come in handy. According to YCharts, RAAX's beta is only 0.64x .

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