Inflation-Linked Bonds for Inflationary Periods?
Interest rate versus inflation rate sensitivity
September 2022. Reading Time: 10 Minutes. Author: Nicolas Rabener.
SUMMARY
- Inflation-linked bonds are considered inflation-hedges
- However, these have lost almost as much as plain-vanilla bonds in 2022
- The sensitivity to interest rates matters more than that to inflation
INTRODUCTION
Inflation is the biggest issue facing the U.S. and is more important to citizens than crime, health care, or immigration according to a Pew Research Centre survey from May 2022. Given inflation of close to 10% this year, this is unsurprising.
Unfortunately, the financial advice retail investors are receiving for dealing with inflation is often poor. For example, a recent Forbes article highlighted five options, where the first one is investing in a high-yield savings account that pays up to 1.5% interest per annum. Inflation was 8.3% in August in the U.S., which implies a negative real return of 6.8%.
The second option recommended by Forbes was investing in inflation-linked bonds, which is also often referenced by professional investors. We previously noted in an article (Inflation-Themed ETFs: As Complicated as Inflation) that these types of fixed-income instruments were not highly correlated with inflation as their principal amounts get adjusted to changes in the consumer price index with a delay.
In this research article, we will explore the performance of inflation-linked bonds in year-to-date 2022.
PERFORMANCE OF INFLATION-LINKED BONDS
Investors can buy single inflation-linked bonds like Treasury Inflation-Protected Securities (TIPS) directly or via ETFs. We focus on three ETFs that provide exposure to inflation-linked bonds from the UK, European, and U.S. governments. These manage between $800 million to $30 billion in assets and charge management fees from 0.09% to 0.19% per annum.
