The Best Canadian ETFs for Fighting Inflation

The recent series of interest rate cuts by the Bank of Canada (BoC), culminating in a 50-basis point reduction this October, highlights a strategic pivot from inflation control to economic stimulation.

After successive rate reductions of 25 basis points in June, July, and September, the Bank is shifting focus, aiming to bolster an economy that's been lagging in terms of GDP per capita growth since 2015 (coincidently, when Justin Trudeau became prime minister and the Liberal Party came into power).

The message seems clear: inflation is moderating towards the long-term target of 2%, and now the priority is economic revitalization (good luck when the Canadian economy consistently eschews our bountiful natural resource reserves in favor of pumping housing and immigration).

For those who vividly remember 2022—a year marked by simultaneous declines in stocks and bonds which undermined the traditional "diversified and balanced" 60/40 portfolio—finding robust investment solutions to counter inflation is crucial.

In this article, I’ll highlight three of my top ETF picks linked to commodities and real assets that can serve as effective hedges against inflation. Each selection is based not just on their theoretical benefits but also on practical outcomes realized during 2022, including one that I personally hold.

Global X Crude Oil ETF (HUC)

Crude oil is one of the most straightforward inflation hedges for investors, as it historically reacts positively to inflationary pressures. To gain exposure to crude oil without investing directly in oil producer stocks, Canadians can consider HUC.

HUC does not hold physical barrels of oil. Instead, it tracks the Solactive Light Sweet Crude Oil Winter MD Rolling Futures Index ER, which involves holding oil futures contracts. These contracts are agreements to buy or sell oil at a predetermined price at a specified time in the future.

Specifically, HUC tracks the futures for the winter months (December), aiming to minimize the impact of contango. Contango is a market condition where futures prices are higher than the spot price, leading to a negative roll yield when futures are rolled from one month to the next, which can erode returns.

By focusing on December contracts, HUC aims to reduce negative roll yield, although this choice might lead to a slightly lower correlation with the current spot prices of oil. Nonetheless, HUC proved effective in 2022; it rose by 26.52% during a period of high inflation.

However, it's worth noting that the ETF's management expense ratio (MER) is relatively high at 1.11%, due to the costs associated with managing futures contracts.

CI Auspice Broad Commodity Fund (CCOM)

One notable weakness of HUC is its concentrated focus solely on crude oil futures, which makes it sensitive to inflation but also exposes it to various idiosyncratic risks unique to the oil market.

Factors such as geopolitical tensions, OPEC decisions, and environmental policies can all cause significant, inflation-unrelated volatility in oil prices.

For those seeking a broader approach, CCOM might be a more suitable option. CCOM tracks the Auspice Broad Commodity Excess Return Index, which includes commodity futures contracts across three sectors: Agriculture, Energy, and Metals.

This diversification spans commodities like corn, cotton, soybeans, sugar, wheat in agriculture; crude oil, gasoline, heating oil, and natural gas in energy; and copper, gold, and silver in metals.

A critical aspect of CCOM's strategy is its use of a trend-following approach, allowing the ETF to take risk-off positions when a particular commodity is in a downtrend. This means it can go "flat" or hold cash, helping to avoid severe drawdowns.

Although CCOM debuted on 2022-09-22, making it too recent to assess its performance during the worst of the inflationary period, its U.S. counterpart, the Direxion Auspice Broad Commodity Strategy ETF (COM), returned 8.71%.

While this return was not as high as HUC's, it came with much lower volatility, making CCOM an easier hold for many investors. Additionally, CCOM offers a more affordable MER of 0.66%.

Purpose Diversified Real Asset Fund (PRA)

The "gold standard" of inflation-resistant Canadian ETFs, and a component of my personal portfolio, is the PRA. This ETF stands out for its comprehensive approach to hedging against inflation by tracking six inflation-sensitive sectors: energy, agriculture, precious metals, base metals, real estate, and utilities.

PRA is distinctive not only in its sector coverage but also in its investment methodology. Within each sector, the ETF can hold both futures contracts and equities. For example, in the energy bucket, you might find crude oil futures alongside shares of major oil companies like Exxon Mobil.

What truly sets PRA apart is its risk parity approach to asset allocation. This strategy involves weighting each bucket based on its overall contribution to portfolio risk, ensuring that no single sector dominates.

Did this strategy prove effective? In 2022, PRA returned an impressive 16.74% with distributions reinvested, which was highly tax-efficient due to its corporate class structure. With a MER of 0.72%, PRA sits comfortably between CCOM and HUC in terms of cost.

A final word on investing in inflation-hedging ETFs

Some of you might be wondering if now the right time is to allocate towards these ETFs – after all, the BoC has seemingly won the inflation fight.

To answer this, I talked to Kevin Black, head of sales at Purpose Investments. Here’s what he had to say:

“Do commodities perform well with inflation, or is it the rise in commodity prices (inputs) that causes inflation? For this reason, it's essential to invest in commodities before inflation hits, not once it's already underway.”

“Since the 1960s, we've experienced two significant commodity price spikes. One was driven by demand, the other by supply constraints. Currently, we could face both demand and supply issues. Social agendas, such as the green movement, are creating outsized demand for metals and rare earth materials, compounded by food and energy insecurity.”

“Additionally, many producers have reduced their capital expenditure since the highs of 2014. Even if investment resumes, exploration has lagged, and mines take time to develop. This situation could lead to a massive commodities boom, potentially spiking inflation.”