e-fundresearch: What is the fundamental difference between an ordinary fixed-rate government or corporate bond and an inflation-linked bond?
Blanchard: In a fixed-rate government bond all Cash Flows (coupons and redemption amount) are fixed / constant. In an Inflation-Linked bond they are both indexed to an inflation index, so the cash flows do actually behave like price indexes. In other (and technical) words the nominal amount (i.e. the bond quantity) is indexed to inflation instead of being constant.
e-fundresearch: What is the total market size of inflation-linked bonds in EUR? Which regions and segments do you focus on?
Blanchard: According to Merrill Lynch indices, the full value of the Euro Government Inflation-Linked bond market was estimated at ? 255.279 billions as of October 8th, 2008. This universe is also represented by the most well-known Inflation index: the BARCLAYS Euro Government Inflation-Linked Bond All-Maturities Index. It is comprised of 4 government issuers: France (around 52.6% as of today), Italy (32%), Germany (9.4%) and Greece (6%). The inflation-linked bonds mainly use two kinds of inflation indices: European inflation (75.1%) or French inflation (24.9%).
As far as the SGAM FUND Bonds ? IL fund management is concerned we believe that transparency is a key feature to investors: we mainly focus on investing in this universe and do not rely on complex performance drivers, so no significant diversification outside such as credit, forex, equities ?mostly bonds within the universe. However, we may use EUREX future (low cost, very liquid, quick way to adjust duration) or Inflation-swaps (a simple way to get exposed to inflation without using too much cash, but cost is higher so less often used)
e-fundresearch: How large is the universe in terms of number of issuers?
Blanchard: Currently 22 issues (vs. around 240 issues for the Euro Governement fixed-rate bond indices such the IBOXX ? Sovereigns index or the Citigroup EGBI). That is why bond picking (e.g. Rich and Cheap analysis) is more essential to in an Inflation fund than to a fixed-rate bond fund.
e-fundresearch: Which investment process do you apply for inflation-linked bonds and how does it differ?
Blanchard: We use a top - down approach :
1. We concentrate on the main performance drivers:
- duration management and real yield curve positioning,
- exposure to inflation,
- country selection (among 4 countries, e.g. Germany in times of flight-to-quality),
- arbitrage between inflation indices (European vs. French).
2. Avoid market timing and high turnover as Inflation-Linked Bonds are less liquid than fixed-rate bonds
We do think that performance indicators used by the market and brokers (e.g. the so-called ?carry? or the ?breakeven?) are not relevant to the asset managers. What matters is (risk-adjusted) total return measures such as Sharpe ratios, and so on. The real-time monitoring of such indicators enables us to adopt a practical approach because actual returns it what matters at the end of the day, not the breakeven or other sophisticated measure that has sometimes nothing to do with the performance.
e-fundresearch: Please explain the mechanics of inflation-linked bonds with respect to nominal and real yield, expected, real and published inflation. How does the investor have to interpret the various terms?
Blanchard: Very complex question. In fact as an investor you do not necessarily need to pay attention to these details. You just need to know whether or not bonds will perform or not or whether inflation will be perceived as higher or lower in the next few months.
An IL bond is mostly sensitive to the following factors (by order of decreasing importance):
- the general level of interest rate (via its sensitivity to interest rates or its duration)
- inflation surprise (or unanticipated inflation)
- and more marginally the appetite for the Index-Linked asset class
The real yields is the conventional Internal rate of return that has been adopted by the market to reflect the value of the bond (you may also express this value in terms of ?Clean price? like for fixed-rate bonds). This expected inflation (at the IL bond maturity) is embedded in the value of the IL bond. It can be (roughly) approximated by the difference between the (nominal) yield of a fixed-rate government bond of the same maturity and the real yield of the inflation-linked bond, but this is an imperfect proxy.
You may refer to the first and second section of the attached presentation if you need more clarification on these points.
e-fundresearch: Is it possible to calculate similar figures like YTD and is it possible to forecast returns for inflation-linked bonds?
Blanchard: YES, but this is not easy since you have to hypothesize on 2 parameters (published inflation over a given horizon AND change in the inflation expectations over this horizon) instead of one parameter in the case of fixed-rate bonds (the change in the nominal yield). In practice, being right on these 2 parameters is difficult.
It is like trying to guess what will be the level of the DAX index at year end if you already know exactly what will be the German growth? not an easy task.
You may refer to the last slide second section of the attached presentation for more clarification. y current guess is that the Inflation-Linked bond will perform as well as fixed-rate government bonds considering the fact that:
- they are mostly exposed to duration and
- Inflation expectation have probably reached a low point following the end of the commodity bubble we have observed recently
e-fundresearch: What kind of correlation do inflation-linked bonds have with fixed-rate bonds?
Blanchard: Normal times it is very significant. You may consider that the correlation between the returns are close to 100% when inflation expectation do not change significantly.
e-fundresearch: How does risk management for inflation-linked bonds differ from fixed-rate bonds?
Blanchard: You have to take into account more performance drivers (in practice the 4 above drivers for IL bonds)
e-fundresearch: Which performance did inflation-linked bonds have over the last few years in absolute terms and relative to your benchmarks? How did the fund perform and how would you comment the performance and performance attribution?
Blanchard: Please refer to the attached presentation (pages 5 and 19).
e-fundresearch: What is the outlook for inflation and inflation-linked bonds. How would you describe the risk-return characteristics of inflation-linked bonds?
Blanchard: We believe there is a potential for higher inflation in the long run:
- Structural trends regarding labor costs
- Changes in consumption habits
- Climate changes
- Geopolitical risks surrounding oil extraction
- Oil prices may resume their long-term rising trend at any time
Inflation expectations have moderated very significantly since July 2008. The market has been frightened by all non-standard asset classes including Inflation-Linked bonds in the wake of the credit crisis, even though these bonds are mainly ? government bonds.
So there is definitely a nice entry point for investors that still hold some cash: they may enter into a specific part of the Euro Government market at discounted prices. So more expected return for a given level of risk, that is a given level of duration in Inflation-Linked bonds.
e-fundresearch: Thank you very much for the interview!
Performanceergebnisse der Vergangenheit lassen keine Rückschlüsse auf die zukünftige Entwicklung eines Investmentfonds zu. Wert und Rendite einer Anlage in Fonds können steigen oder fallen. Anleger können gegebenenfalls nur weniger als das investierte Kapital ausgezahlt bekommen. Auch Währungsschwankungen können das Investment beeinflussen. Beachten Sie die Vorschriften für Werbung und Angebot von Anteilen im InvFG 2011 §128 ff. Die Informationen auf www.e-fundresearch.com repräsentieren keine Empfehlungen für den Kauf, Verkauf oder das Halten von Wertpapieren, Fonds oder sonstigen Vermögensgegenständen. Die Informationen des Internetauftritts der e-fundresearch.com Data GmbH wurden sorgfältig erstellt. Dennoch kann es zu unbeabsichtigt fehlerhaften Darstellungen kommen. Eine Haftung oder Garantie für die Aktualität, Richtigkeit und Vollständigkeit der zur Verfügung gestellten Informationen kann daher nicht übernommen werden. Gleiches gilt auch für alle anderen Websites, auf die mittels Hyperlink verwiesen wird. Die e-fundresearch.com Data GmbH lehnt jegliche Haftung für unmittelbare, konkrete oder sonstige Schäden ab, die im Zusammenhang mit den angebotenen oder sonstigen verfügbaren Informationen entstehen.