Our Favorite Inflation-Protected Bond Funds

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Our Favorite Inflation-Protected Bond Funds

by Michael Herbst | 03-27-09 | 10-07 AM

The inflation-protected bond category has regained its legs. Funds in this category had a rough late 2008. Falling inflation expectations, coupled with the forced selling of inflation-protected securities by some large investors that needed to raise cash for other needs, dealt double-digit losses to most of the funds in the category. The group's swoon was so severe that the yield difference between Treasury Inflation-Protected Securities and plain-vanilla Treasuries, known as the breakeven inflation rate, reflected expected inflation rates of less than 1% annualized over the coming decade, or well below more-normal levels. The category has begun to regain lost ground for the year to date through March, gaining 4.5% on average. That showing stems in part from the government's continuing efforts to bolster the financial system, including its purchases of government securities, such as agency mortgage-backed securities, nominal Treasuries, and potentially TIPS. Our Analyst Pick Vanguard Inflation-Protected Securities VIPSX has benefited from TIPS' recovery, having posted a 6% gain in 2009. Fellow Analyst Pick Harbor Real Return HARRX has also righted itself with an 8% return. That offering's wider-ranging mandate weighed on its returns in 2008, yet its recent performance reinforces the confidence we have in the ability of its subadvisor (the formidable bond powerhouse PIMCO) to manage the risks of its broader style. Many of those funds that ventured even further beyond U.S. government fare, such as GMO Inflation Indexed Plus Bond GMIPX and Legg Mason Partners Global Inflation Management SBGLX, are still digging themselves out of the deep hole they fell into in 2008. Despite the category's recent rebound, the market's inflation outlook is far from clear. Although the government's resuscitation efforts are intended to ease the flow of credit and reinflate fallen asset prices, the economy is still facing significant head winds. Those factors are in flux, but our preferred characteristics for funds in this category are not. Veteran management teams, such as those backing our two picks, are essential. Low expenses also provide an edge, as lower hurdles deliver a bigger chunk of the category's relatively modest longer-term returns to investors.
Analyst Picks: Category YTD Return (%) Harbor Real Return Instl HARRX Vanguard Inflation-Protected Secs 8.27 5.6 3-Year Return (%) 5.32 5.14 4.01 5-Year Expense Return Ratio (%) (%) 0.57 0.2

VIPSX
Average
1 2

4.51

3.69

3.35

0.84

Fund has a front load. Closed to new investors.

Returns through 3/26/2009.

Harbor Real Return HARRX This fund hasn't been around long, but it brings a lot to the table. This fund's approach involves the use of forward contracts, non-U.S. bonds, and numerous other bells and whistles as a way to give investors an advantage over the plain-vanilla market for TIPS without adding too much out-of-sector risk to the portfolio. Of course, investing in a fund of

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Our Favorite Inflation-Protected Bond Funds

http://news.morningstar.com/FundAnalystPicks/printNews.asp?id=IP

that type requires a lot of trust in PIMCO's risk-management abilities. We think the firm has done a lot to deserve such trust, though, and the fund's modest 0.57% expense ratio (capped indefinitely) makes it a truly compelling option. Vanguard Inflation-Protected Securities VIPSX When it comes to delivering a quality option for those in search of a plain-vanilla TIPS fund, it's tough to beat Vanguard. This fund's manager shifts assets around modestly to take advantage of oddities along the maturity spectrum but otherwise doesn't take on much additional risk in the portfolio. The best way to compete with a strategy of that type--and in an asset class this homogenous--is to charge as little as possible. The fund's 0.20% expense ratio therefore makes it among the best options available.

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6/11/2009 6:48 PM