If you're considering adding an inflation hedge to your portfolio, check out this list of Medalist funds in the inflation-protected bond category.
By Karen Wallace | 02-14-18 | 05:00 AM | Email Article

After laying low for several quarters, inflation is again on investors' list of worries. This is reflected in the widening spread between the yield on 10-year Treasury bonds and 10-year Treasury Inflation-Protected Securities--the so-called break-even inflation rate--which is often viewed as a market-based proxy for investors' inflation expectations. After steadily falling to 1.66% in late June, the break-even inflation rate ratcheted wider over the back half of 2017 and so far in 2018; it was over 2% as of Feb. 9. 

Karen Wallace is a senior editor with Morningstar.com. Follow her on Twitter @KarenW60602.

In an interview with Morningstar, Mihir Worah, who is the CIO of asset allocation and real return and also a managing director at PIMCO, said he believes investors' concerns stem from fears that inflation could be finally approaching the Federal Reserve's target, which could accelerate interest rate rises. And concurrent fiscal stimulus could exacerbate this burgeoning inflation. 

"We're starting to see inflation go up and at the same time, you've got the big $1.5 trillion tax cut that's over 10 years and now we're just hearing of the budget deal, which adds about another $100 billion, $150 billion per year to the deficit for the next couple of years," Worah said. "People are concerned about what this will do at a time when inflation is already starting to move up."

In this environment, investors may be wondering if they need an investment that provides explicit inflation protection in their portfolio. The answer is not necessarily: Many younger investors already have some built-in protection from inflation in the form of steadily increasing wages and a heavy exposure to equities, which have a good chance of outpacing inflation over long periods. This article can help you determine if you need explicit inflation protection in your portfolio at all, and if so, how to right-size your allocation.

But investors who are nearing retirement or those who are already drawing income from their retirement portfolios might have a growing need to preserve their long-term purchasing power. In that vein, we put together this list of Medalist funds in the inflation-protected bond category, along with a closer look at some of the funds.

  Vanguard Inflation-Protected Securities  
Unlike many funds in the inflation-protected bond Morningstar category, Vanguard Inflation-Protected Securities is a pure inflation play: It does not court additional risk by looking for extra sources of return in commodities, high-yield bonds, or other assets. Though it hews closely to its benchmark, it's not a true index fund as manager Gemma Wright-Casparius can add and remove risk via duration, curve position, and the break-even rate, depending on where she sees the best opportunities. The fund earns a Gold rating owing to its low fees, excellent long-term performance, and  Vanguard's strong stewardship, says manager research analyst Brian Moriarty. 

 PIMCO Real Return
To beat the Bloomberg Barclays U.S. TIPS Index, the team (run by Mihir Worah and Jeremie Banet) looks to obtain cost-efficient exposure to U.S. Treasury Inflation-Protected Securities and other inflation-linked bonds by seeking better execution than passive investors. Although U.S. TIPS and, to a lesser extent, other global inflation-linked bonds dominate the portfolio, the fund can invest up to 20% of assets in other sectors, such as developed and emerging-markets sovereigns, corporates, and securitized fare, says Miriam Sjoblom, a director in Morningstar's manager research group. The fund's multifaceted approach, backed by PIMCO's formidable global fixed-income resources, earn the fund a Morningstar Analyst Rating of Silver. 

 FlexShares iBoxx 3 Year Target Duration TIPS ETF
It often surprises investors to learn that inflation-protected bond funds are sensitive to interest-rate changes. When yields rise, TIPS prices come under pressure--the longer the bond, the more pressure--even if inflation is pushing up their principal value at the same time. That's why some investors opt for shorter duration TIPS funds, such as FlexShares iBoxx 3-Year Target Duration TIPS Index, which offer exposure to the TIPS market while maintaining a three-year target duration. Its short and targeted duration provides a high correlation to immediate inflation changes and reduces unintended interest-rate risk, says analyst Phillip Yoo. But though its fees are reasonable, there are comparable funds at lower costs. This tempers our recommendation of the fund somewhat; it earns a Morningstar Analyst Rating of Bronze.

Securities mentioned in this article



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Karen Wallace does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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