Jonathan Baltora, Head of Sovereign, Inflation and FX at AXA IM, covers the 3 key strategies to consider when investing in inflation-linked bonds:
1. All maturities inflation-linked bonds
2. Short maturities inflation-linked bonds, which have duration capped at 5 years
3. Inflation breakevens

Watch this 4th video in AXA IM’s Inflation series to learn how the three different approaches for inflation-linked bonds may be applied according to different market and economic conditions.

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Inflation-linked bonds, also known as inflation-indexed bonds or real return bonds, are a type of bond that provides investors with a hedge against inflation. These bonds are designed to protect investors from the erosive effects of rising prices over time.

There are two main approaches to inflation-linked bonds: the principal adjustment approach and the coupon adjustment approach.

Under the principal adjustment approach, the principal value of the bond is adjusted periodically to reflect changes in inflation. This means that the value of the bond increases with inflation, providing investors with a real return that keeps pace with rising prices. The interest payments, or coupons, on these bonds are typically fixed in nominal terms, meaning that they do not vary with changes in inflation.

On the other hand, the coupon adjustment approach involves adjusting the coupon payments on the bond to account for changes in inflation. This means that as inflation rises, the coupon payments increase, providing investors with a higher income. The principal value of these bonds remains constant, regardless of changes in inflation.

Both approaches have their advantages and disadvantages. The principal adjustment approach offers more certainty to investors, as they are guaranteed a fixed real return over the life of the bond. This makes these bonds particularly attractive to long-term investors who want to preserve their purchasing power over time.

However, the coupon adjustment approach may be more appealing to income-seeking investors who rely on the bond’s coupon payments to meet their cash flow needs. With the coupon payments tied to inflation, these investors can benefit from higher income during periods of rising prices.

It’s important to note that the specific features of inflation-linked bonds can vary depending on the issuing country or institution. For example, some bonds may have a cap or a floor on the adjustments to the principal or coupons, while others may have a lag in the adjustment process.

Investors interested in inflation-linked bonds should carefully consider their investment objectives and risk tolerance before making a decision. These bonds can be an effective tool for protecting against inflation, but they may also carry risks, such as interest rate risk and credit risk.

Overall, inflation-linked bonds can be a valuable addition to an investment portfolio, particularly for those who are concerned about the impact of inflation on their purchasing power. The different approaches to these bonds offer flexibility to investors, allowing them to choose the strategy that best aligns with their investment goals and preferences. As always, consulting with a financial advisor is recommended to ensure that the investment aligns with individual circumstances and goals.