| To link or not to link: outlook on inflation-linked bonds |
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| 10/12/2006 | |
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In recent months, a number of institutional investors have resisted linkers. The BP South African Pension Fund, valued at £268 million, shelved plans to invest in them because "inflation linked bonds are hard to come by at the moment." Meanwhile, a JP Morgan report on linkers notes that they continue to "underperform conventionals. TIPS were the worst performers, down around 0.5% versus a maturity-matched portfolio of Treasuries in total return terms. Euro area breakevens have stabilised recently but we see risks of another sell-off, driven by lower inflation expectations and momentum." Inflation expectations have shifted downward since October, according to the report. "Inflation is expected to have peaked in 2006, with 2007 and 2008 showing falls across different economies. Markets expect US inflation to stabilise around 2.3% and Euro inflation to converge close to 1.9% over the long run." Bucking the trend Not everyone is avoiding the sector. Fortis Investments in Paris is overweight on Euro inflation and underweight on French inflation because France is better insulated from the rise in commodities prices due to its extensive nuclear energy reserves. It has shifted into non-French linkers within the Euro-zone as they are more susceptible to energy price rises. "We see headline inflation going back up because of seasonal effects represented mainly by food prices," says Elizabeth de Larauze, a Euro fixed-income product specialist at Fortis with €780 million in assets invested in Euro linkers. The firm expects headline inflation to be softer in France than in other Euro zone countries, even as yields back up from current levels. At the same time, Fortis has reduced its active duration bet to slightly short its benchmark (-0.10 years) as they believe the market is overpriced and expect inflation to trend higher by year end. If the move seems counter-intuitive, it is because most market strategists expect a continued economic slowdown in the U.S. and Europe. Indeed, inflation expectations have moderated since summer and commodity prices have come off their highs. Core inflation (excluding food and energy) in the U.S is just under 3%, and the consensus has bet on a slowdown. In Europe, inflation remains muted and GDP growth has dropped from 0.9% in the second quarter to 0.5% in the third. Core CPI is 1.5% and headline inflation dropped from 2.3% to 1.7% in September. "It is a good time to move into inflation-linked bonds because inflation expectations, and thus breakevens, are so low," says de Larauze. V.B |
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Articles of the same Topic : Portfolio management |
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