The boutique fixed income manager says the role of ILBs in a portfolio has been heightened by the current trend of institutions investing for a specific return after inflation. This is in contrast to striving for outperformance of benchmarks which Ardea says are less relevant to end-clients, and often vary from institutions’ investment objectives.
 
By their very nature, ILBs provide an inflation plus return – making them the ultimate objective and outcome driven investment.
 
Principal and portfolio manager at Ardea, Tamar Hamlyn said the manager had seen strong inflows from superfunds at the industry, corporate and government levels who are looking for tools to cope with ongoing market volatility.
 
“Our recent discussions with clients have really focused on how best to deliver to their specific investment objectives and how we embed these objectives into the investment strategy. What has always seemed obvious to us, and is perhaps just coming to the attention of the industry, is the natural fit of ILBs in a portfolio being constructed to meet a specific outcome. Especially where the objective is an after-inflation return,” Mr Hamlyn said.
 
Mr Hamlyn acknowledged in the current low inflation environment it could be easy for investors to become complacent towards the risk of inflation on a portfolio, but pointed to the higher likelihood of inflation spiking unexpectedly, rather than dropping suddenly – as a key reason for always including an element of inflation protection.
 
“Currently, inflation is at historically low levels, a factor which makes it easy for short term investors to overlook the potential risk of inflation to a portfolio. However, not including inflation protection in a portfolio is effectively making the bet that inflation will continue to drop – an outcome which would be difficult to achieve given how low inflation is already.
 
“With governments around the world engaging in multiple rounds of quantitative easing, the inflationary backlash is a question of when, not if. At such low levels, investors should be locking in inflation protection while it can be accessed relatively cheaply, and ensuring they have it in place for the full term of their investment horizon,” Mr Hamlyn said.
 
Ardea is the investment manager of a range of products offered to institutional investors, including customised mandates, a traditional benchmark-focused unit trust and an outcomes-based inflation-plus fund which is also available to retail investors.

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“Institutional investors increasingly want access to both the domestic and global inflation-linked bond markets, allowing them to make tactical decisions regarding allocations between the two based on their views of global market conditions,” Omega Managing Director George Vassos said.

“This value proposition for investors is supported by strong growth, with both domestic and international inflation-linked bonds returning more than six per cent over the last six months, in a time of high volatility in the global markets.”

Omega began managing mandates for both Australian and global inflation-linked bonds in the past 12 months as the institutional market looked to increase allocations to this asset class.

“The increasing number of baby boomers heading into retirement this decade has shifted the focus from investment strategies relevant for the accumulation phase of a superannuation plan to those that are more in line with the objectives of a retiree – a concentration on income and a return on investment over the rate of inflation,” Mr Vassos said.

“This market wants to increase their exposure to asset classes that deliver consistent income and don’t diminish the purchasing power of their retirement pool.”

Mr Vassos said the growth of both domestic and international inflation-linked bonds is linked to the global demographics of superannuation members and the expectation that inflation will generally increase in the next 5-10 years.

“Inflation is definitely at the forefront of the Reserve Bank’s mind in Australia, plus there is the broad expectation that it will pick up around the world – for example China recorded an annualised inflation rate of 6.4 per cent in June,” Mr Vassos said.

Mr Vassos said Omega is one of the few boutique managers to have a mandate for both domestic and international inflation-linked bonds, enabling investors to tailor their allocations between the two to suit their needs. 

He said the increasing appetite for Australian inflation-linked bonds would likely grow the supply and depth in the marketplace, with more issuance expected from Australian governments, both at federal and state level.

“Increasingly, investors are looking for asset classes which are CPI linked or fixed income as a total asset class, and this really fits with our capability across the defensive asset spectrum,” Mr Vassos said.

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