EUROPE – Investors are overestimating the extent to which real estate provides a hedge for inflation – which it does only when inflation is broadly under control, according to fund manager Fidelity.

A white paper published earlier this week claims real estate in fact only provides a hedge against inflation within relatively narrow limits, and that rising capital values offer no protection despite driving an uptick in demand.

In contrast, long-term income data suggest a positive correlation with inflation.

Between 1985 and 2012, income return averaged 6.8%, compared with average RPI of 3.6%.

Fidelity expects income returns to remain high until the end of next year as a result of investors' increased appetite for risk and willingness to buy assets at above-average long-term yields.

Head of real estate Neil Cable told IP Real Estate: "There's a tacit understanding among investors that real estate always provides an inflation hedge. But the data doesn't support that view.

"There is no inflation hedge if inflation races away. Above 6%, the inflation hedge disappears. That doesn't mean that at 6.1% all correlation disappears, but it does mean the inflation hedge is reduced."

The paper suggested investors should be particularly concerned because of medium-term inflationary risks in some markets as central banks withdraw liquidity in the form of quantitative easing.

However, Cable pointed out that, in any case, pension funds' liabilities tended to be capped at between 4% and 6% – below the threshold at which property ceases to act as an effective inflation hedge.

According to the paper, investors are better off employing multi-asset risk-mitigation strategies that anticipate changes in inflationary trends.

"By dynamically exploiting the unique characteristics of each asset class, it is possible to improve the stability of real returns," it said.

But its authors were also cautious on the inflation-hedging potential of other asset classes.

They pointed out that commodities – often used by investors as the inflation-hedging instrument of choice – generate their strongest returns during periods of high and rising inflation, but the effect is reversed when inflation is high but falling.

They also pointed to the risks associated with price volatility when investors use commodities to hedge inflation over short investment periods.