While it could be interesting to explore this question in a broad philosophical sense, we will simply address and summarize some of the “real rates” of return currently available in fixed income.

The real rate of return is basically the nominal or stated rate minus the rate of inflation. Core CPI is currently running 1.6% year over year through February which is the same reading as January and is below the Federal Reserves 2% Target. If you add back food and energy, the rate is 1.1%.

While it is only one factor in determining the attractiveness of an investment, the real rate is a reasonable start to help assess whether or not a fixed income instrument is potentially appropriate.

Currently Treasury Bonds and Agency Mortgage Debt represent a large percentage of the Barclay’s Aggregate US Index and also those ‘total return” funds and “core bond” funds that manage around that index.

10 year Treasury Notes possess a yield of 2.76% and the 5 yr 1.74%. The Bloomberg US Mortgage Backed Securities Index effectively yields 2.92%. While there is some room to garner a positive real yield, it does not come without risk. The main risk is interest rate risk as the duration on both these types of instruments exceeds the real yield and with a rise in interest rates could wipe out any gain from the inflation premium. While there are legitimate reasons to hold some in an actively managed fund, it is a good time to review if your firms portfolio has too much in an asset class with a low real yield.

The US Bloomberg Corporate Bond Index yields 3.06% and offers slightly more real yield but with added credit risk as well as the duration risk inherent in most debt classes. The Emerging Market Sovereign Debt Index as represented by the I-Share EMB, yields 5.05% which begins to look attractive relative to US real yields. It does carry additional risk as it is a basket of disparate governmental policies in addition to reasonably high duration.

The real yields available with the markets listed above could turn into fantasy if the price of the bonds are driven down by credit, duration or country specific risk to name a few and the real yield you purchased becomes much less or even negative.

To avoid measuring the difference between these nominal products and the rate of inflation, an investor could invest in a bond tied directly to the rate of inflation or CPI. These are available globally but are most pronounced in the US and most know them as TIPS or Treasury Inflation Indexed Notes.

Currently the real yield on a 5 yr TIP is -.44 and on the 10 yr it is .61%. Those are “really” low to take on the interest rate risk but may be worth the risk if inflation were to begin to increase and not very worthwhile if inflation were to continue to decrease.

Given the search for real yield in a fixed income market with low rates combined with serious interest rate, credit and inflation risk, we will examine the inflation indexed asset class more in-depth in additional pieces to determine if a placement in a “real return” bond or portfolio of bonds makes sense for your clients.


Tom Koehler, CIO