ZPS Inflation Linked Notes Assessment-Part Four

This four part series is designed to aid wealth management firms, pension consultants and family offices with their decision making process within the real return segment.

The series began with an inflation review that included the current state of the market in addition to TIPs characteristics and unique valuation metrics.

We proceeded in piece two to outline the various ways to obtain exposure to inflation linked notes using ETFs as our examples. Then in piece three, we delved into actively managed mutual funds and gave each a score for suitability in a portfolio. Most, including some popular names with massive AUM did not make the cut.

As we wrap up the series with a description and rationale for our favored Zenith Score Fund, we set the stage with inflation rates globally.

Region/country CPI Month end YOY
US 2.13% up May 14
English 1.51% down May 14
European .40% down May 14
German .853% down May 14
Chinese 2.42% down June 14
Australian 2.9% March 14-Next End of July
Brazil 6.374% up June 14
South Africa 6.836% up May 14
France .691% up May 14
Japan 3.71% up May 14
India 7.018% up May 14
Mexico 3.753% up May 14
Iceland 2.238% down May 14
Canada 2.276% up May 14
New Zealand 1.50% April 14-Next end of July

These various inflation rates can help explain in part the differences in performance among the various funds. Since US inflation has been muted until recently, the ETFs such as WIP have outperformed over the last year. This is the ETF we did not recommend for a long term strategic placement and stick to this view despite its out-performance vs funds that focus solely on US TIPs. Our rationale is that the product was in the right place as (non-US) inflation was higher than US inflation in many cases.

WIP, the SPDR DB International Government Inflation-Protected Bond ETF produced a 8.26% return through 7/10/14 while TIP-I-Shares only produced a return of 3.8% largely due to its focus on US TIPS. ILB (Pimco’s active ETF) which has the ability to invest in a variety of global inflation indexed notes produced a 7.04% return.

Rather than choosing between US and non-US inflation, we feel that investors should embrace a manager with a broader opportunity set in order to take advantage of inflation investments on a global scale.

Mentioned above we like the Pimco Global Advantage Inflation Linked Fund (ILB). This fund combines active management within an ETF structure while continually assessing the entire global inflation linked bond opportunity set.

This opportunity set consists of the US, Developed Markets-ex US and emerging markets. Since some of the countries may have small markets, the manager of this fund has a threshold for liquidity and they also maintain a mostly investment grade threshold for inclusion in the portfolio.

It is important to note that their performance enhancers and detractors have a lot to do with the direction of real interest rates. We covered that topic in the first part of this series as the general goal is to garner high real yields and profit from a decline in those yields.

They do a reasonable job of finding value in real yields that are projected to fall and to underweight those that are suspected rise.

The combination of a wider global mandate with active management in a multi-currency portfolio is favorable to us here at Zenith and at least over the last year it is paid off vs at least a few actively managed funds.

We described and scored four funds in the third part of this series. ILB has provided a superior return over the last year in comparison to all of the reasonably mandate constrained funds. American Century, T-Rowe, Vanguard, Fidelity and Pimco all did worse in the open end space than ILB was able to accomplish in the ETF structure.

Within the mutual fund lineup we provided, American Century was the worst while the others struggled to post stellar results as well, again due to their muted mandate and opportunity set.

We highly suggest that your firm examine your inflation indexed notes exposure. Specifically, we recommend that you address the breadth of your managers’ opportunity set and how well they perform within that set.

As part of this vetting process, we encourage your firm to include ILB as one of the top contenders for your inflation indexed note exposure.

If you have any thoughts or questions with regard to this four part series, please reach out and we would be happy to help sort through this nuanced asset class.


Tom Koehler-CIO