With the global printing presses running overtime, bond yields rising, major yield curves steepening and food, energy and commodity prices all shooting up, the markets are worried about inflation. The odds are that are you too.
Given that inflation is best described as the price of goods and services rising and that businesses are the ones that sell goods and services, equities are often a good long-term hedge against inflation. While this cannot be understated, many investors are currently overweight equities – and adding more to this overweight position is perhaps not the correct call.
Likewise, some investors – often late in their lives or with low-risk tolerance – want ‘safer’ and/or income-yielding investments, which equities generally do not fit.
While traditional fixed coupon bonds get eaten for breakfast as inflation lifts, there is a unique little subset of bonds that track inflation: the descriptively called ‘inflation-linked bonds’ (ILBs); also known as ‘Treasury inflation-protected securities’ (Tips) in the US.
Generally-speaking, ILBs operate as follows:
- They pay bondholders a fixed interest rate on their capital amount, but
- Their capital amount is raised by inflation (often CPI in South Africa).
Thus, because the capital amount rises by inflation, the fixed interest rate paid on this also rises by the same amount. Therefore the bondholder is, in theory, protected against inflation. In practice though, their performance depends on real yield movements – which have risen in South Africa as the country was downgraded by the credit rating agencies, resulting in many ILBs underperforming inflation recently.
There are also several other risks, not least of which is credit risk. More subtly, there is the matter of how inflation is calculated (there are many arguments about how CPI understates our country’s real inflationary pressures).
Given this background, how can you practically invest in ILBs?
Well, other than directly buying the individual ILBs in the market, you can go either via an exchange-traded fund (ETF), or you can invest in RSA Retail Bonds.
The table below compares the major elements of these two routes into ILBs:
|Name||Code||Index||Size||Tracking error||TIC (%)*||Bidding spread**||Gross yield||Liquidity|
|Ashburton Inflation ETF||ASHINF||FTSE/JSE IGOV||R340m||0,16%||0,41%||0,68%||2,85%||Daily|
|NewFunds ILBI ETF||NFILBI||ILBI Index||R60m||0,40%||0,34%||0,95%||3,04%||Daily|
|Satrix Inflation-linked Bond ETF||STXILB||S&P SA Sov. ILB 1+yr||R152m||0,18%||0,25%*||1,61%||3,34%||Daily|
|RSA Retail Bond (3-year inflation-linked option)||Unlisted||N/A||N/A||0,00%||0,00%||Unlisted||2,50%||3-year duration***|
|RSA Retail Bond (5-year inflation-linked option)||Unlisted||N/A||N/A||0,00%||0,00%||Unlisted||3,75%||5-year duration***|
|RSA Retail Bond (10-year inflation-linked option)||Unlisted||N/A||N/A||0,00%||0,00%||Unlisted||4,75%||10-year duration***|
Sources: Various ETF providers, RSA Retail Bonds website, author’s own calculations
* TIC = Total investment cost (Satrix only discloses its ILB ETF’s total expense ratio (TER), which we have used above in place of the TIC)
** As of intra-day on March 24
*** After the first year a request for redemption can be made subject to a penalty fee.
What is clear from the above is that any allocation into this space comes with trade-offs:
- While the Satrix ILB ETF is cheaper than the other ETFs with a higher gross yield, it appears to have a worse bidding spread (i.e. entry-cost) than the others.
- Although the Ashburton Inflation ETF is poor on most of its metrics, it is the largest and most liquid of the ETFs.
- Finally, while buying an RSA Retail Bond that is linked to inflation may not offer the best yield or relatively good liquidity, it does offer the investor a bond without any indirect fees (i.e. it is the ‘cheapest’).
Thus, the correct ILB investment depends on the investor.
If you are looking to make a large, one-off allocation in this space, Satrix’s ILB ETF is probably the best as you only pay the spread once (or not at all if you go directly via Satrix).
Alternatively, if you do not need the money you are investing (i.e. you can afford to take liquidity risk), look at the RSA Retail inflation-linked bonds and push their duration out to the extreme; both the five-year and 10-year gross yields beat the ETF options).
While ILBs have performed poorly as our country’s credit risk has risen, discarding them as an asset class would be premature and they do offer an interesting option for those wanting some stability, safety and income with a degree of an inflationary hedge in place.
Listen to Ryk van Niekerk’s interview with Duggan Matthews, CIO of Marriott Investment Managers (or read the transcript here):