Since they were first issued by the U.S. Treasury in 1997, inflation-linked bonds (also known as Treasury Inflation-Protected Securities, or TIPS) have become an important new asset class with valuable properties for fixed income investors. At the Howard Hughes Medical Institute, Ellen Safir began using TIPS tactically in a core plus portfolio when they were first introduced, and subsequently managed a $3 billion leveraged portfolio using global inflation-linked securities. Her success with them then has made inflation-linked bonds the centerpiece of New Century Advisors' investment offerings.

By guaranteeing investors the rate of inflation—removing the uncertain impact of inflation on portfolio values—the only remaining variable of TIPS is real return, a function of the overall economy's supply and demand for capital. Real interest rates are less volatile than nominal interest rates over long periods. Government policies, both fiscal and monetary, are now geared toward growth and inflation, while many investors are still concerned about deflation. Although designed chiefly to provide a hedge against inflation, TIPS also perform reasonably well in low-inflation and deflationary environments. TIPS thus protect the market value of the total portfolio from a decline in real interest rates as well as from an unexpected rise in inflation. Because of their low correlation with stocks and bonds, TIPS offer excellent diversifying properties for total portfolios, and are now included within the strategic asset classes of most leading institutional portfolios.

New Tools, Enhanced Flexibility

All of these characteristics provide fixed income managers with a whole new set of tools that offers enhanced flexibility to their investment strategies.

Nominal treasuries may be added to a portfolio of TIPS—or TIPS to a portfolio of Treasuries—to add value, depending on the inflationary environment. For example, when the market anticipates lower-than-expected inflation, adding conventional Treasuries can help enhance total returns. Likewise, when "breakeven inflation" rates (the difference in yields between nominal Treasuries and TIPS of the same term) are unduly low—a scenario that favors TIPS over nominal Treasuries—TIPS can be added to a portfolio of nominals.

Global Inflation Linked Bonds

U.S. TIPS