5 Inflation-Beating Bond Picks
It’s an axiom of fixed income investing that inflation is a bond holder’s worst enemy. But what’s an investor who requiresregular income to do when the interest rate environment changes, and rising rates and inflation are forecasted? Not only does the investor risk watching the nominal value of his/her bond portfolio diminish, he/she also loses the opportunity to reinvest on more favorable terms as interest rates climb.
Given that scenario, we’ve collected a number of underutilized products and strategies that income investors can avail themselves of when the winds of inflation begin to howl.
1. Get Protected
Inflation-protected securities (IPSs) offer income investors a popular method of staving off the effects of inflation and rising rates. These securities are comprised of two components, a regular bond coupon that pays a stated rate of interest, and a Consumer Price Index-linked element that adjusts the principal value of the bond up or down with changes in the index. They are offered by the federal government as Treasury inflation-protected-securities (TIPS) while in Canada they’re sold as real return bonds (RRBs).
Recently, municipalities and corporations have been offering their own versions of IPSs. These may have tax advantages over federally issued IPSs, but be sure to check with your financial advisor to see that the benefits of these issues outweigh the purchase of higher-rated, federally backed bonds. (Learn more in-depth details about IPSs in our article, Inflation-Protected Securities – The Missing Link.)
Risks to IPSs:
· Extended drops in the CPI (i.e. deflation) will erode the principal of an IPS, potentially leaving investors with a negative absolute return.
· As with any fixed income investment, the creditworthiness of the issuer is paramount. Best to know who you are buying, and to allocate your funds accordingly.
2. Go Short
Another popular strategy in a rising rate environment is to keep the duration of your fixed income investments short. Shortening the duration of your bond portfolio means you receive cash sooner than longer duration bonds and therefore you can reinvest that cash sooner at higher interest rates in an inflationary environment. Conversely, in a decreasing interest rate environment you may also want to consider extending the duration of your portfolio. By staggering your maturities from between three months to a year – or by simply investing in a prudently managed, money market fund that does that for you – you can safely capitalize on rising interest rates.
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