During the brief period between the release of most Covid-19 measures and the start of the war in Ukraine, inflation was the order of the day. And although we currently live in a more complex and visibly less global world, inflation still seems to be the number one issue for financial markets.
Federal Reserve chief Jay Powell has demanded all the attention by saying that the Fed must move quickly to tighten monetary policy and be prepared to act even more aggressively if necessary to tackle excessive inflation. The Fed chairman called for a series of rate hikes this year and steps to reduce the central bank’s balance sheet.
His comments came just days after the central bank raised its policy rate by 25 basis points. This is expected to be the first in a series of rate hikes and the next one in May could be as big as 50 basis points. Most Fed officials predict that interest rates could rise to 2.8 percent by 2023.
So central bankers do not seem to be distracted by the war in Ukraine and recessionary concerns that accompany this. Or perhaps they have no choice at all, as the war puts further upward pressure on energy, food and commodity prices in the short term while inflation is already high. Inflation in the US is expected to reach 5.2 percent in 2022, according to The Economist Intelligence Unit.
Short-term bond yields
Meanwhile, there is much turmoil in the bond market about exactly how far the Fed will go and to what extent the central bank can curb inflation. Moreover, it is mainly short-term bond yields that have risen, flattening the shape of the yield curve. An inverted yield curve has traditionally been a fairly accurate predictor of recession. Bill Gross, the founder of Pimco and a former “Bond King”, has a gloomy outlook and has warned that the Fed has limited room to raise rates without seriously damaging the economy and housing market.
In times of rising inflation, some investors are turning not only to equities and/or commodities, but sometimes also to inflation-protected bonds. Also in Europe, where expected inflation in the eurozone is 3.7 percent and even 6.4 percent in the Netherlands, this bond category is proving popular with inflows of about 15 percent of total assets under management over the last 12 months, according to Morningstar data. The Bloomberg Euro Inflation Linked index rose 6.7 percent over the same period to end-February 2022 versus a loss of 4 percent for the Bloomberg Euro Government Bond index. Over the past five years, these inflation-linked bonds have also outperformed conventional European government bonds, but the index has lagged behind over longer periods.
Inflation at Work
The list of best-performing funds within the Morningstar EUR Inflation-Linked Bonds category over the past 12 months (of which a distribution-free fund class is available in the Netherlands) is headed by the Inflation at Work fund of CapitalatWork, an independent asset manager under Luxembourg-based insurer Foyer Group.
The fund has been managed by Erwin Deseyn since its launch in 2003. Paul Smets joined Deseyn in 2009 and together they also manage the Corporate Bond, Short Duration and Government Bond funds. Both men have been active at CapitalatWork for over 20 years. Although the fund finished in the first decile of its EUR Inflation-Linked Bond category over the past 12 months, it landed in the middle of the pack over the past 15 years.
Further down the list is a fund with a Morningstar Analyst Rating of Gold namely Vanguard’s Eurozone Inflation-Linked Bond Index Fund. The index fund managed by the London indexing team led by Rachel Baxter aims to replicate the performance of the Bloomberg Global inflation-Linked: Eurozone - Euro CPI Index.
According to Morningstar analysts, this is an attractive proposition for investors seeking a core position in inflation-linked Eurozone government bonds. However, the average duration of this bond market may put the fund at a slight disadvantage in times of rising interest rates compared with active funds that can adjust the duration. Still, as is often the case with Vanguard, the low management fee of this fund is a big plus.
Thomas De fauw is a research analyst at Morningstar. Morningstar analyses and evaluates investment funds based on quantitative and qualitative research. Morningstar is one of Investment Officer’s knowledge partners and each week ranks five investment funds or providers.
This article originally appeared on InvestmentOfficer.nl.
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