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| Risk & Reward |
Inflated Expectations
John Ferry
09/01/2005
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As with a
conventional bond, changes in the behavior of interest rates will also affect
the relative performance of TIPS. “You’re exposing yourself to opportunity cost
because if rates go up then you’ve locked yourself in at a lower rate,”
Oberhoffer explains. “You’ve got a dilemma as you look at markets today because
interest rates are still near pretty historic lows. If you lock in at 1.8
percent, then you’re going to be really annoyed if a year from now you could
have gotten 2.5 percent.”
Because these instruments have a very low risk
profile, portfolio managers suggest they be used as a foundation for a
fixed-income portfolio. “Inflation-linked bonds are generally going to be among
the lowest risk assets conceivable, so the less your risk appetite, the higher
should be the concentration of TIPS,” Pimco’s Brynjolfsson notes.
Alternative Treatments
There are other methods of ensuring a real return
on investments. One simple way is to invest in a real return mutual fund or
managed account. Some of these invest in TIPS and other international
inflation-linked government securities. (France and the United Kingdom are among
the larger issuers of inflation-linked bonds.) Pimco, for example, manages a
real return fund that is mostly invested in TIPS, but also includes other
assets, such as high yield or emerging market bonds. The fund is discretionary
rather than static, and as such it will not be exactly correlated with U.S.
inflation. Instead, it is designed to protect against inflation while
outperforming the market. To do so, it takes on more risk than a portfolio that
simply invests in TIPS. Another type of mutual fund/ managed account invests in
commodities or securities that track commodity prices, because these tend to
rise in an inflationary environment. Real return funds typically charge a 3 to 4
percent sales charge; other fees vary.
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