Opening
In June 2022, Statistics Canada reported that the Consumer Price Index had risen 8.1% year-over-year—the highest level since January 1983. Nominal returns that looked adequate in a 2% inflation environment were deeply inadequate in an 8% environment. Real returns—returns adjusted for inflation—on most traditional investments had turned sharply negative. A GIC yielding 2.5% represented a negative real return of roughly 5.6%. For alternatives investors focused on real assets, the moment seemed validating. But the dynamics creating 8.1% inflation were simultaneously creating headwinds for many alternative investments.
What Happened
The CPI number was the culmination of months-long acceleration from late 2021. Shelter costs (housing, rent, utilities) had risen 7.4%. Food prices were up 8.8%. Transportation costs—driven heavily by energy prices from the Ukraine invasion—were up 12.0%. Energy costs were elevated across the entire inflation basket.
The Bank of Canada had already begun raising rates. The March 2 hike to 0.50% was followed by April 13 at 1.00%, and by June, the policy rate was at 1.50% with signals of more hikes coming. The central bank was in a difficult position: inflation was running at 8.1% while real rates—the policy rate minus inflation—were sharply negative at roughly negative 6.6%. To get real rates to neutral levels (around 2%), the BoC would need to raise the policy rate to something in the range of 10%+. (Statistics Canada, June 15, 2022; Bank of Canada, June 2022)
For traditional fixed income, the situation was dire. A 2.5% GIC locked in a negative 5.6% real return. A 3.5% government bond represented a negative 4.6% real return. Purchasing power erosion was severe—an investor putting $100,000 in a 2.5% GIC would see real value decline by roughly $5,600 per year to inflation alone. (Statistics Canada Consumer Price Index, June 2022)
By contrast, real assets seemed more attractive. Real estate capturing rental income or commodities benefiting from the inflation spike. The question was whether alternatives investors had actually positioned themselves for this scenario, or simply gotten lucky.
Why It Matters
The 8.1% inflation reading had three major implications for Canadian alternatives investors, cutting in different directions.
First: Real returns matter, and traditional fixed income is genuinely uncompetitive. An accredited investor should not be locking in negative 5-6% real returns by holding GICs and government bonds. If inflation stays elevated for several years, the erosion from negative-real-return assets is severe. This realization drove investors toward alternatives, toward real estate, toward infrastructure.
This isn't an argument that negative-real-return assets are bad. Sometimes investors need safe, liquid assets and accept purchasing power costs. But accredited investors with choice should not be holding substantial portfolio exposure in negative-real-return assets in an 8% inflation environment.
Second: Real assets preserve nominal value, but not always real returns. Real estate renting for $100,000 per year might rent for $108,000 per year in an 8% inflation environment. But there's a critical offset: rising rates. The Bank of Canada, fighting to cool inflation, was raising rates aggressively. Rising rates put downward pressure on asset valuations. A real estate asset valued at $1 million at a 5% discount rate might be worth $800,000 at a 7% discount rate—a 20% decline in value even if cash flows remained stable. This is the squeeze: inflation erodes purchasing power while rising rates reduce valuation multiples applied to cash flows.
Third: Assets benefiting from inflation spike are different from assets benefiting from steady inflation. Commodities and energy companies benefit from surprise inflation spikes. Regulated utilities and mature infrastructure benefit from steady inflation with stable rates. The 8.1% reading was the first-derivative shock—rapid acceleration—driving asset price moves reflecting shock rather than secular inflation protection.
This isn't an argument against real assets. It's an argument for understanding what kind of inflation you're hedging for and whether your positioning matches the risks you're managing.
What to Do
For Canadian accredited investors, the 8.1% inflation environment suggested practical approaches:
Explicitly model real returns for every holding. Calculate the real return (nominal return minus expected inflation) for each major position. Negative-real-return positions should typically be small, not the bulk of a portfolio.
Scrutinize inflation-linked alternatives carefully. Understand the mechanism by which inflation flows through to returns. Does the asset have explicit inflation pass-through (like regulated utilities)? Or does it benefit from higher nominal pricing power (like real estate operators)? The former is more reliable in sustained inflation.
Test alternatives for rate sensitivity. Model what happens when the central bank raises rates aggressively. Valuations typically decline even as inflation is rising. A real estate position might return 6% nominal (negative 2% real) at purchase, then 4% nominal (negative 4% real) if the BoC raises rates by another 150 basis points.
Consider commodity and energy exposure thoughtfully. Commodity prices are volatile and mean-reverting over long periods. Don't confuse short-term commodity-spike tailwinds with longer-term inflation-hedging characteristics.
Diversify across inflation regimes. Rather than positioning your entire alternatives portfolio for inflation today, build exposure across strategies performing differently depending on how inflation evolves.
Closing
The 8.1% inflation reading was shocking not because inflation itself was unexpected—the trajectory had been clear for months—but because of the magnitude and its implications. For alternatives investors, the moment validated the case for real assets but exposed uncomfortable truths: real assets weren't immune to rising-rate pressure, inflation hedges can fail when rates rise faster than inflation, and the period from March 2022 onward would require active management and flexibility.
Alts Insider provides educational content for Canadian accredited investors. This is not investment advice. Always consult qualified professionals before making investment decisions.