Conventional wisdom says bonds should be avoided in a high-inflation environment. But inflation- linked bonds may well be an attractive option.
HSBC Global Asset Management has launched what it says is the first inflation-linked bond fund focused on emerging markets. The HSBC Emerging Markets Inflation-linked Bond Fund is available only to sophisticated or accredited investors.
Patrice Conxicoeur, chief executive of Sinopia Asset Management (Asia-Pacific), says there has been an 'absolute sea change' in the past few months in the level of interest in inflation-linked bonds. Sinopia, part of the HSBC group, manages the fund.
'We have been investing for 10 years now, and talking about inflation-linked bonds to institutional investors for over five years,' says Mr Conxicoeur. 'Until quite recently we were not seeing a lot of interest. We have an audience looking at inflation-linked bonds with very interested and technical eyes.'
Amid signs of keen interest, Barclays has rolled out a new global linkers bond index. State Street Global Advisors also launched the first international inflation-protected bond Exchange Traded Fund earlier this year.
Mr Conxicoeur expects the fund to attract some US$500 million. So far it has raised about US$250 million.
With such bonds, the principal is indexed to inflation, so in an inflationary environment, the investor benefits with rising principal and coupon payments. In the case of emerging markets, there is the added kicker of an expected currency appreciation. Currency exposure, however, is a risk as well, and the portfolio is generally unhedged.
Inflation in emerging markets averages about 8 per cent. With real rates between 3-4 per cent, this suggests the fund could deliver a total return of over 10 per cent.
The portfolio is expected to be 31 per cent invested in Mexico and 25 per cent in Brazil. Other exposures include South Africa, Turkey, Colombia and South Korea.
Mr Conxicoeur says emerging market inflation- linked bonds remain a fairly 'small corner' of the bond market. There are some US$250 billion in securities, compared to the developed market inflation- linked securities of between US$1.5 trillion and US$1.7 trillion.
'There is a rising interest and rising need in all countries where there is a middle class beginning to worry about saving for retirement,' he says. 'For investors who do not have exposure to local currency emerging market debt, the fund is an interesting way to dip their toes in.'
The asset class remains attractive, says Mr Conxicoeur. 'The countries show real rates that are basically positive. The return that investors can hope to earn, give or take the currency movement, is the real interest rate plus inflation.'
The fund aims to pay dividends quarterly, at an annual rate of 7-9 per cent. The annual management fee is 1.25 per cent.
This article was first published in The Business Times on 25 June 2008.
