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Mark Carlson, FlexShares

Facing up to rising inflation with fixed income ETFs


Mark Carlson, Senior Investment Strategist at Northern Trust Asset Management’s FlexShares ETFs, with USD19 billion in assets, celebrates the efficiency that ETFs have brought to fixed income trading, particularly in the latest scenario of rising interest rates and rising inflation.

Mark Carlson, Senior Investment Strategist at Northern TrustAsset Management’s FlexShares ETFs, with USD19 billion in assets, celebrates the efficiency that ETFs have brought to fixed income trading, particularly in the latest scenario of rising interest rates and rising inflation.

“For years and years, fixed income trading, excluding ETFs, has been over the counter so there hasn’t been a whole lot of transparency,” Carlson says. “But with ETFs and their disclosure of holdings, along with their ebbs and flows of redemptions and creations, you will find that ETF pricing during the day, especially in volatile periods such as currently with the situation in Ukraine, the funds may technically trade at a discount or premium to their NAV, bringing a level of transparency into the fixed income market.”

Carlson describes his firm’s ability to quickly allocate to fixed income markets as similar to pulling a lever. The firm’s core bond strategy, the FlexShares Core Select Bond Fund (BNDC) is a fund of funds ETF which comprises several of the firm’s ETFs and allows the portfolio managers to operate almost an intraday type of trading. “They can go look at the valuation on each ETF and make the decision right there,” Carlson says.

“It’s revolutionary – one of those developments that while having taken time to gain marketplace acceptance, we are now at a point where many asset management firms and advisors have embraced ETFs. Now you can find a whole menu of fixed income strategies available to you that are not possible in the mutual fund structure.”

The rising inflation and interest rates scenarios have been part of FlexShares’s approach to planning for their clients since our inception in 2011, Carlson says. “We have always asked: What is the goal for managing inflation against your liability stream? We feel it’s important to look at what is your goal as an investor. Is it a younger investor looking to fund a child’s college education, and concerned about inflation over the shorter term? Or is it building wealth over the longer term, or a family office or a high net worth individual worried about multi-generational wealth protection?

“We have identified asset classes that respond to inflation over one to five years, five to 15 years and 15 years plus.”

One of the key tools in the toolbox has been Treasury Inflation-Protected Securities (TIPS) which have been available since 1997. The principal value of TIPS rises as inflation rises, providing purchasing power protection.

“TIPS capture unanticipated inflation; you are really buying insurance against inflation, and they are good in the short term, but over time, because they are inherently fixed income securities, they have real interest rate components exposing investors to interest rate risk,” Carlson says.

“TIPS can be negatively impacted by higher rates so they are not a magic bullet but they do a good job capturing unexpected inflation in the short-term.”

Another classic hedge against over the long term are commodities and natural resources. “This is where our natural resources fund comes into play,” Carlson says. “We look for companies that own or control the assets in the ground.  Commodities are popular right now as an investment class because of the supply and demand dynamic. It’s been a perfect storm for commodity inflation with the reopening of economies in 2021 and dealing with supply constraint,” Carlson says.

“Even the most ardent of ESG investors are beginning to understand that in order to get to a greener global economy, you need some dirty assets or assets in the ground,” Carlson says. “Lots of aluminium, rare minerals and plastics – there is going to be continued demand for nearly every classic resource and it will be a long and tumultuous transition from fossil-based to renewable energy.”

One of the great investment management debates is the ability of active management and its associated use of factor-based analysis, which traditionally has been used in equities but is increasingly being used in fixed income too, Carlson says.

“The philosophy is that in fixed income investing, making your initial investment is the most important factor you can look at, where you select it on the yield curve, and secondly how much credit exposure you take in the portfolio. With our Core Select Bond portfolio, the portfolio manager is making those two big decisions on a daily basis.

“And there is real time execution on those portfolios so that in extremely volatile environments like today, you want portfolio managers to be able to pull the correct levers.”

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