Scientific Beta

We test whether there is an inflation risk premium in the cross-section of equities, considering a range of different inflation measures.

Investment practice has shown growing interest in equity strategies that emphasise stocks with favourable sensitivity to inflation. A host of equity indices and exchange-traded funds promising inflation protection have recently been launched. Scientific Beta also offers indices with a favourable inflation tilt and manages inflation risk in its multi-factor offering. For investors considering such strategies, a crucial question is whether these equity portfolios incur a cost in the form of lower expected returns.

Against this backdrop, we test whether there is an inflation risk premium in the cross-section of equities. Our comprehensive analysis considers a range of different inflation measures. Next to headline inflation, we also test whether exposure to core, energy, food, durable goods, non-durable goods, and services inflation is priced. Analysing diverse metrics is important because their attributes may lead to different pricing effects.

In the first part of our analysis, we show that we can reliably capture exposure to headline, energy, and non-durables inflation. However, it is challenging to predict exposures to core, food, durables, and services inflation out-of-sample. These results indicate that investors can create equity portfolios that hedge headline, energy or non-durables inflation, but not the other components.

Our analysis then examines long-term unconditional compensation as well as conditional compensation during periods when inflation signals negative economic growth. We find no evidence of an unconditional premium for headline inflation or its components. Furthermore, we do not find conclusive evidence of a conditional premium. Among the components, only non-durable goods inflation shows a consistently negative premium in conditional analysis, though this result weakens with multiple testing adjustments.

Overall, our findings challenge results in previous papers and indicate that protecting against inflation risk does not lower the expected returns of equity investors.