Rising inflation may threaten the market's largest stocks, but it does have some potential beneficiaries.
The Horizon Kinetics Inflation Beneficiaries ETF (INFL), which launched in January, identifies and groups those names to offer investors protection in inflationary environments, its co-portfolio manager James Davolos told CNBC's "ETF Edge" this week.
"The first thing we want to do is ... identify an end market that we believe is inflationary, which we broadly refer to as hard assets, so, a tangible, finite asset that can benefit from pricing pressures," Davolos said in a Monday interview.
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Then, his team looks for companies with "capital-light" business models — those that don't take on a great deal of risk or spend excessively in order to turn a profit — and reasonable valuations.
The result thus far has been promising. INFL is up nearly 18% since its launch and has accrued over $624 million in net assets under management.
The ETF's top holdings are Charles River Laboratories, Texas Pacific Land Corp., PrairieSky Royalty, Franco Nevada Corp. and Deutsche Boerse. It also has substantial positions in Intercontinental Exchange, Wheaton Precious Metals Corp., Archer-Daniels-Midland and Brookfield Asset Management.
"Two areas that you'd be pretty hard pressed to argue against being inflationary over the past decade are higher education and health care," hence INFL's top holding, pharmaceutical service provider Charles River Laboratories, said Davolos, also a vice president at Horizon Kinetics.
Charles River helps expedite the early stages of new drug development more cost-effectively than most other organizations, which could lead mega-cap biotech and pharmaceutical companies to its business when pricing pressures rise, he said.
"They have the facilities in place, they have the networks, they have the databases where it doesn't cost them very much to put a lot more throughput through their existing system," Davolos said.
"To the extent that there's more and more demand in an inflationary environment, Charles River's going to benefit both through higher volume and higher pricing, kind of having that one-two punch ... on the upside."
Texas Pacific Land's value add is a little different. "Truly one of a kind," the company earns royalties on oil and gas production in West Texas and benefits from developments on the land it owns, Davolos said.
In effect, giants such as Exxon Mobil, Chevron and EOG Resources pay Texas Pacific to operate in its West Texas oilfields and other organizations pay it to build pipelines, roads, power lines or water systems on its land, making for cost-efficient returns, he said.
It's similar with Franco Nevada, which earns its royalties from the precious metal mining business, Davolos said. Archer-Daniels-Midland, which processes the world's crops, should earn a higher "crushing margin" by pushing higher input costs to their customers, he said.
As for the stock exchanges, they should benefit from inflation's "ripple effects," Davolos said.
"The Intercontinental Exchange, Deutsche Bourse, the CME, they operate very large derivative exchanges, which allow people to both hedge and speculate on all of this instability or volatility that might arise as a function of inflation," he said. "If there's a couple trillion dollars more [in] notional derivative volume, the exchanges spend very little money to basically earn that revenue and a lot of that converts into operating income."
INFL's positive track record is likely just getting started, Davolos added.
"I think the long-term trend still points to pretty strong reflation ultimately shifting into inflation," he said.
The ETF closed less than half of 1% higher on Friday.