Updated Saturday, July 12, 2014 as of 6:05 PM ET
Portfolio - Fixed Income
Pimco Joins Invesco Finding Value in TIPS
by: Anchalee Worrachate and Susanne Walker
Monday, February 25, 2013
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(Bloomberg) -- At a time when the bond market expects inflation to stay at about the past decade’s average, the biggest buyers of government debt say they need protection from rising consumer prices as central banks focus on growth.

Pacific Investment Management Co. and Invesco Ltd. say growing central-bank tolerance of inflation means securities with interest or principal tied to consumer prices are the ones to own. Global expectations indicated by the gap between yields on so-called linkers and government bonds reached a 21-month high of 1.70 percent, Bank of America Merrill Lynch indexes show. Economists in Bloomberg surveys forecast consumer-price gains of 2.72 percent in 2013, in line with the 10-year average.

After four years of stimulating economies, central bankers are starting to see signs of accelerating growth, spurring some bond investors to prepare for a rise in yields from record lows. Index-linked securities are favored because sovereign-debt returns are being erased by what little inflation there is.

“There’s an element of central banks, whether they say it or not, being more relaxed about allowing inflation to rise,” Paul Mueller, a London-based fund manager at Invesco Asset Management, a unit of Invesco Ltd., which manages $713 billion, said in a telephone interview Feb. 19. “While I don’t think we are going to see inflation escaping to very high levels, it does make sense to have protection.”

Global Stimulus

Policy makers from the Federal Reserve to the Bank of England to the Bank of Japan pumped more than $3.5 trillion into economies to stimulate growth during the five years following the start of the deepest global slump since World War II. Global gross domestic product will expand almost 2.4 percent this year, from 2.2 percent in 2012, a Bloomberg composite of economist estimates shows, increasing speculation that inflation will also start rising.

Investors seeking insurance against future price rises have helped inflation-protected issues in developed markets outperform regular securities by 0.25 percentage points this year through Feb. 20, according to Pimco indexes. Linkers have beaten non-indexed bonds in the U.K., Japan, Germany, Italy, Sweden, Australia and New Zealand.

Securities with maturities of 10 years or more across the G-10, except Japan, are losing out to shorter-dated debt as investors demand more compensation for the risk of inflation, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies.

Bond Yields

U.S. Treasury Inflation-Protected Securities, or TIPS, have lost 1.32 percent this year as Treasuries declined 1.3 percent, according to the Barclays U.S. Inflation-Linked Bond index and the Barclays U.S. Government Comparator Bond Index, which is adjusted to reflect the longer duration of TIPS. They returned 7.26 percent in 2012, compared with 3.3 percent for the duration-adjusted government bond index.

Yields on U.S. 10-year notes dropped last week by four basis points to 1.96 percent amid speculation the Fed’s asset purchases may support bond prices, according to Bloomberg Bond Trader data. The benchmark 2 percent note due in February 2023 rose 11/32 or $3.44 per $1,000 face amount, to 100 10/32. The yield on 10-year TIPS due January 2023 dropped on the week to negative 0.59 percent.

Ten-year notes yielded 1.97 percent and the TIPS rate was minus 0.56 percent today as of 8:45 p.m. in London.

BlackRock Picks

“One should be looking to own inflation-linked bonds rather than nominal bonds and that argument is more compelling the further out the curve you go,” Martin Hegarty, the co-head of BlackRock Inc.’s inflation-linked bond funds, which holds more than $28 billion of assets, said in a telephone interview Feb. 20.

Hegarty, whose company oversees $3.8 trillion as the world’s largest money manager, favors inflation-linked debt with three- to seven-year maturities in Germany, Italy and the U.K. He is also buying TIPS with maturities of one to two years, even though BlackRock doesn’t anticipate any immediate jump in consumer prices unless there is a surge in energy costs.

The global break-even rate, a measure of inflation expectations, is at 1.64 percentage points, compared with a 10- year average of 1.2 percentage points and a peak of 2.14 percentage points in July 2008, Bank of America Merrill Lynch indexes show.

The break-even rate in the U.S. was as high as 2.61 percentage points this month, from 2.24 percentage points Sept. 4. It rose to 2.73 percent on Sept. 17, four days after the Fed announced an open-ended bond buying plan to keep pumping funds into the financial system, the highest since May 2006. The central bank announced the additional Treasury purchase program of $45 billion per month on Dec. 12.

‘Good Time’

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