Investing for Inflation – 3 Ways to Protect Your Portfolio and ProfitOctober 4th, 2012 by Marc Prosser
1) Buy Inflation Linked Bonds
2) Buy Bond Funds With A Short Duration (learn more about duration here)
3) Buy A Short Duration High Yield Corporate Fund
Here is an explanation of each, and the PIMCO funds which fit each strategy.
Investing for Inflation Strategy 1: Buy Inflation Linked Bonds
Treasury Inflation Protected Securities (TIPS) are an example of an inflation linked bond. The principal value of a TIPS (the amount a bond holder receives at maturity) , moves up and down with inflation. These bonds are a bit hard to understand, as their market value does not move directly with inflation. However, as a general rule, these bonds should do well compared to “normal” bonds in periods of increasing or high inflation. (You can learn more about investing for inflation with TIPS here)
PIMCO offers several TIPS bond ETFs. The difference between them is the average maturity of the bonds the funds hold. PIMCO’s TIPS funds are different from their other more well known funds, as they are passively managed index funds. As a result, they have a much lower annual expense ratio than their actively managed funds, of 0.2%. (you can learn more about bond fund fees here)
Here is a list of the three TIPS ETFs that PIMCO offers. As you can see from the table below, the problem with all these funds is that have negative yields.
|ETF Name & Symbol||SEC 30 Day Yield|
|PIMCO 1-5 Year TIPS Index Fund (STPZ)||-1.89%|
|PIMCO Broad US TIPS Index Fund (TIPZ)||-1.69%|
|PIMCO 15+ US TIPS Index Fund (LTPZ)||- 1.32%|
In addition to the three funds above, PIMCO offers the PIMCO Global Advantage Inflation-Linked Bond Strategy Fund (ILB), which primarily holds non-US bonds. However, its SEC yield is also negative.
Investing for Inflation Strategy 2: Buy Bond Funds With A Short Duration
Shorter duration bond funds have two advantages over longer duration funds:
- They lose less value when interest rates rise
- The bonds mature more quickly so the fund reinvests in the new bonds which are paying a higher rate of interest faster.
PIMCO has 4 bond ETFs which I consider be short duration. However, assuming a modest rate of inflation 2.5% per year, two of three would have a negative real rate of return.
|ETF Name and Symbol||SEC Yield Minus 2.5%|
|PIMCO Enhanced Short Maturity Fund (MINT)||-1.77%|
|PIMCO 1-3 US Treasury Index Fund (TUZ)||-2.35%|
|PIMCO Short Term Municipal Strategy Fund (SMMU)||-2.25%|
Investing for Inflation Strategy 3: Buy A Short Duration High Yield Corporate Fund
Inflation can make it easier for a corporation to pay back debt. Assuming that profits rise with inflation, a corporation will have more money to pay back debt. While this is not so important for companies with strong financials, it can make a difference for those in a tighter financial position. Combine this with the benefits of short-duration funds in general, you have a winning combination for those investing for inflation.
For this reason we like the We like the PIMCO 0-5 Year HIgh Yield Corporate Bond Index Fund (HYS).
The 30 day SEC yield is currently 4.38%. Of course, this fund has credit risk. Unlike most of the ETFs described above which hold government debt, this fund holds much riskier corporate debt. We are going to assume that defaults cost the fund 1.5% in returns per year. (The actual default rate would be higher.) So if you take the yield of the fund, minus a modest inflation rate, minus a modest default rate, you can generate a positive after inflation return with this fund.
4.38% – 2.5% (inflation) – 1.5% losses due to defaults = 0.38%
Our choice for inflation fighting with PIMCO funds?
The PIMCO 0-5 Year High Yield Corporate Bond Index Fund (HYS)
Learn Bonds discussing this article:
- How Much Extra Yield Can You Earn For Taking Extra Risk?
- The Limitations of Credit Default Swaps
- The Basics of Credit Spreads
- World Bond Funds: Do You Know the Risks?