Inflation prediction: Rising inflation isn't likely Examining the prospect of deflation and inflation in the current market By Michael Smith, Consulting Director, Private Client Services Russell Investments August 2009 As the economy shows signs of recovering, the specter of inflation is the next big concern for many investors. Given current economic conditions, we recognize why investors would be concerned. At this point, Russell doesn't believe that inflation or deflation pose a significant threat. While deflation might have been a more likely scenario, the stimulus activities of the federal government show it's serious about preventing deflation. We currently feel confident that the government's actions will deter this threat. The absence of deflation might suggest that inflation is more likely. An increased money supply and government budget deficits have led many to predict historically high inflation rates in our future. Others disagree, citing factors that include modest economic recovery scenarios and restrained lending by banks. The June Blue Chip Economic Forecast,® which examined forecasts on the U.S. economy through the end of 2010 from the economists of 50 different investment and academic organizations (including Russell's own Mike Dueker),¹ projects U.S. inflation levels in the 2% range beyond 2009. These numbers are in line with inflation expectations inferred by the Treasury Inflation Protected Securities (TIPS) market, as well as Russell's own forecasting models. These forecasts suggest, from a historical perspective, normal inflation levels and no need for Russell to explicitly make changes in our strategies to address inflation. How Russell funds are positioned While Russell doesn't predict above-normal inflation rates, this doesn't prevent our money managers from taking positions based upon their own inflationary views. If they believe inflationary concerns should influence individual portfolio positioning, they can reflect this within their own security selection. Commodities have long been recognized as one of the better inflation hedges, although they are extremely volatile and very risky to invest in without a thorough understanding of the risks. While our strategies don't incorporate a commodity fund, our equity money managers can and do hold commodity-related securities within our other equity funds. Outside of commodity related stocks, equities in general have provided a good longterm hedge against inflation. Going forward, we don't expect that relationship to stop, because companies will eventually be able to pass increased costs to their customers. An allocation to equities is appropriate for all long-term investors seeking to outpace inflation. Within our bond funds, Treasury Inflation Protected Securities (TIPS) are the most noted inflation hedge. Our fixed-income money managers are allowed to hold allocations to these instruments, but at the moment, hold very little within our fixed-income funds. TIPS are currently pricing modest inflation expectations and our money managers appear to agree. TIPS are Treasuries, and without a clear inflation threat, managers are finding much more attractive risk/return payoffs in other areas of the bond market. Hedging inflation with diversification Outside of stocks and bonds, there is one additional segment of Russell's strategies that should provide inflation protection. All Russell diversified model strategies and LifePoints® Funds contain a strategic allocation to a real estate securities fund. As the economy heats up, real estate investors are able to capitalize on higher rents turning into higher returns, creating a natural inflation hedge. So in the unlikely event that Russell and our managers get caught off guard by unanticipated inflation, there is a dedicated fund in the strategy that should thrive in these conditions. Russell doesn't anticipate deflation or historically high rates of inflation in the near future. Russell model strategies and LifePoints Funds remain invested across multiple managers and asset classes reflecting our long-term belief that a diversified strategy is the best way to weather any unforeseen storm. It's unlikely we'll reposition our strategies to explicitly address inflation concerns in the near-term. However if inflationary alarms arise, we employ best-of-breed money managers who stand ready to position portfolios accordingly. Fund objectives, risks, charges and expenses should be carefully considered before investing. For a prospectus containing this and other important information call Russell at 1-866-676-7680 or go to the prospectus and reports page to download one. Please read the prospectus carefully before investing. 1 Blue Chip Economic Forecasts®l is published monthly by Aspen Publishers, 76th Ninth Avenue, New York NY, 10011. While 52 organizations responded to the survey, only 50 forecast out as far as 4th quarter 2010. These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. Model Strategies are exposed to the specific risks of the funds directly proportionate to their fund allocation. The funds comprising the strategies and the allocations to those funds have changed over time and may change in the future. The LifePoints® Funds are a series of fund of funds which expose an investor to the risks of the underlying funds proportionate to their allocation. Investment in LifePoints Funds involves direct expenses of each fund and indirect expenses of the underlying funds, which together can be higher than those incurred when investing directly in an underlying fund. The information, analysis, and opinions expressed herein are for general information only. Nothing contained in these materials is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional. Please remember that all investments carry some level of risk including the potential loss of principal invested. Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment. Diversification and strategic asset allocation do not assure profit or protect against loss in declining markets. Treasury Bills ("T-bills") are short-term debt securities issued by the U.S. government with maturities of usually one year or less. Fixed income investors should carefully consider risks such as interest rate risk, credit risk, securities lending, repurchase and reverse repurchase transaction risk. Russell Investment Group is a Washington, USA corporation, which operates through subsidiaries worldwide, including Russell Investments, and is a subsidiary of The Northwestern Mutual Life Insurance Company. The Russell logo is a trademark and service mark of Russell Investments. Securities products and services offered through Russell Financial Services, Inc., member FINRA, part of Russell Investments. For information on the Financial Industry Regulatory Authority, go to www.finra.org. Copyright© Russell Investments 2009. All rights reserved. First used: August 2009 RFS 09-2257			Subscribe to our Education Center RSS Learn more about using and subscribing to RSS Printer friendly version of this page

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