Is now the time to invest in inflation-linked bonds?

Published 12 April 2022

Nick Sudbury

Investment writer

Important information: The value of investments and the income from them can go down as well as up, so you may get back less than you invest.

THE cost-of-living crisis is affecting people and businesses right across the country with fuel, food and heating prices rising strongly, while many other goods and services are also becoming more expensive. These changes are having a big impact on everyone’s daily lives, as well as the value of their investments.

Investors need to protect and grow the real value of their wealth after taking into account inflation, otherwise the spending power of their capital will diminish over time. This is a significant challenge in the current environment with the UK Consumer Prices Index (CPI) forecast to hit a 40-year high of 8.7% in the fourth quarter of 2022.¹

One potential solution is to invest part of your portfolio in inflation-linked bonds where the principal (the amount of money the issuer agrees to pay the lender at the bond’s expiration) increases in line with inflation. Unlike a traditional bond, the final maturity value could end up substantially higher and the income payments could also rise, as the fixed coupon rate is applied to the inflation-adjusted principal.

It is a complex area where an active manager can add value in a number of different ways including favouring certain countries and issues over others, while controlling the risk. One such is Adam Skerry, who runs the £1.1bn ASI Global Inflation-Linked Bond Fund which features on the Fidelity Select 50.

“Inflation linked bonds can offer protection against higher levels of realised inflation, because they increase in value during inflationary periods. As such, the nominal return is not eroded in the same way that the return on a security not linked to inflation might be,” he says.

ASI Global Inflation-Linked Bond Fund price chart

Source: Morningstar from 2.1.18 to 31.3.22. Basis: bid to bid with income reinvested in GBP. Excludes initial charge.

The fund aims to achieve the return of the Bloomberg World Government Inflation Linked Index (hedged to sterling), plus 0.5% per annum before charges. Over the five years to the end of March it made an annualised gross return of 2.54%, which was slightly ahead of its performance target of 2.48%.

These numbers appear quite modest, but for much of the period inflation was very low, especially during the lockdowns. In the 12 months to the end of February 2020 and 2022 when inflation expectations rose strongly, the fund made net annual returns of 10.84% and 6.07% respectively.

At least 70% of the capital is invested in inflation-linked government bonds issued anywhere in the world. The fund can also hold inflation-linked and traditional investment grade bonds issued by companies and can hedge the currency risk.

Traditional fixed income securities respond to changes in nominal interest rates, whereas inflation-linked bonds react to real interest rates that take into account the level of inflation.

“We cannot rule out a situation where economic growth begins to slow meaningfully while inflation remains elevated, making real yields a very attractive asset class to invest in,” concludes Skerry.

More on ASI Global Inflation-Linked Bond Fund

Source:
¹UK Parliament, 25 March 2022

Five year performance

(%)As at 31 March	2017-2018	2018-2019	2019-2020	2020-2021	2021-2022
ASI Global Inflation-Linked Bond Fund	1.1	2.2	3.8	4.6	3.7

Past performance is not a reliable indicator of future returns

Source: Morningstar from 31.3.17 to 31.3.22. Basis: bid to bid with income reinvested in GBP. Excludes initial charge.

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Overseas investments will be affected by movements in currency exchange rates. The ASI Global Inflation-Linked Bond Fund may invest in corporate bonds and due to the greater possibility of default an investment in a corporate bond is generally less secure than an investment in government bonds. Currency hedging is used by this fund to substantially reduce the effect of currency exchange rate fluctuations on undesired currency exposures. There can be no assurance that the currency hedging employed will be successful. Hedging also has the effect of limiting the potential for currency gains to be made. This fund uses financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.