An investor’s guide to inflation-linked bonds 1

An Investor’s Guide
to Inflation-Linked
Bonds
This document is intended for investment professionals
in the Asia-Pacifc region.
2 An investor’s guide to inflation-linked bonds
Standard Life Investments is a
premier asset manager with an
expanding global reach. Our wide
range of investment solutions is
backed by our distinctive Focus
on Change investment philosophy,
disciplined risk management and
shared commitment to a culture of
investment excellence.
Contents
1 About Standard Life Investments
2 Diverging Inflation Paths Create Opportunities
4 Some Key Concepts
5 Who Issues Inflation-Linked Bonds?
6 Who Invests in Inflation-Linked Bonds?
7 The Benefits of Inflation-Linked Investing
8 A Wide Opportunity Set
10 Managing Currency Risk in a Global Portfolio
11 A Brief History of Inflation-Linked Markets
13 The Role of Inflation Swaps
14 Key Global Inflation Indices
15 Looking Ahead
16 Contact Details
1 An investor’s guide to inflation-linked bonds
Standard Life Investments is a premier asset manager with an expanding
global reach. Our wide range of investment solutions is backed by our
distinctive Focus on Change investment philosophy, disciplined risk
management and shared commitment to a culture of investment excellence.
About Standard Life Investments
As active managers, we place signifcant
emphasis on rigorous research and a strong
collaborative ethos. We constantly think
ahead and strive to anticipate change before it
happens, ensuring that our clients can look to
the fture with confdence.
As at 31 December 2010, Standard Life
Investments managed $245.6 billion on
behalf of clients worldwide. Our investment
capabilities span equities, fxed income, real
estate, private equity, multi-asset solutions,
fnd-of-fnds and absolute return strategies.
Headquartered in Edinburgh, Standard Life
Investments employs more than 850 talented
professionals. We maintain ofces in a number
of locations around the world including Boston,
Hong Kong, London, Beijing, Montreal, Sydney,
Dublin, Paris and Seoul. In addition, we have close
relationships with leading domestic players in
Asia, including HDFC Asset Management in India
and Chuo Mitsui Asset Trust and Banking in Japan.
Our parent, Standard Life plc, was established
in 1825. A leading provider of long-term savings
and investments, Standard Life foated on
the London Stock Exchange in 2006 and is
now a FTSE 100-listed company. Standard
Life Investments was launched as a separate
company in 1998 and has quickly established
a reputation for innovation in pursuit of our
clients’ investment objectives.
Our investors rank among some of the
world’s most sophisticated and high-profle
institutions. They include corporate pension
plans, banks, mutual fnds, insurance
companies, fnd-of-fnd managers,
endowments, foundations, charities, ofcial
institutions, sovereign wealth fnds and
government authorities.
An investor’s guide to inflation-linked bonds 2
Diverging Inflation Paths
Create Opportunities
Inflation is diverging
In the 1990s-2000s, now known as the Great
Moderation, a noticeable feature of the
economic landscape was that infation was
low across most countries despite consistently
strong economic growth. In recent years,
the infation path has looked rather diferent
from one economy to another. Compare, for
example, the US and the UK. The UK’s infation
data has stubbornly exceeded expectations
ever since the crisis, whereas in the US core
infation has tracked obdurately lower. Policy
makers in both countries allege the existence of
large output gaps, yet only the US displays the
classic symptoms. In the UK, unemployment
may be high, but it is not at levels implied by
output gap estimates. Infation is stubbornly
higher than it should be, even when all of the
temporary factors such as tax increases and
the impact of a lower currency are removed,
and even when capacity utilisation indicators
are largely around cyclical averages rather than
at peak levels.
Similarly for Europe, there is a marked
heterogeneity of economic performance. Core
Europe has recovered well from the crisis, led
by Germany where some wage pressures are
starting to appear. Conversely, the plight of the
peripheral EMU countries needs little frther
description. The dilemma for the ECB in terms
of policy making is plain to see. Indeed, with
the Fed still easing quantitatively, the Bank
of England split on the timing of a tightening
and the ECB chairman making it abundantly
clear that action is coming soon, this creates a
frther degree of diference.
While such divergence may complicate
matters for policy makers, it does throw up
opportunities for investors to add value in
bond portfolios.
Having emerged from a period where the world
generally thought infation was tamed, through
one where defation was seen as much more
of a threat, the upswing in infation pressures,
partly in the US and Europe but especially
across many emerging market economies, has
brought infation-linked bonds to the forefront
of many investment discussions.
In recent months, infation expectations have
risen markedly across major markets. This
move has been highly correlated with the
changes in the price of oil and other major
commodities. However infation expectations
over the coming fve years are only at
comparable levels to those experienced prior
to the crisis. In that period, the consensus was
that the authorities had infation under control,
permanently. Questions have to be asked
therefore about why infation insurance is no
more expensive now than then, given the much
higher existing levels of uncertainty.
At this stage of the economic cycle, we would
expect in normal circumstances that investors
should favour real assets, i.e. those with an
implicit or explicit link to infation. However,
this is far from a normal recovery, afer a far
from normal recession. Hence, it is expected
that investors will wish to own a more cautious
mix of real assets than in more normal
circumstances. This may mean a greater weight
in infation-linked bonds, and lower weightings
in riskier real assets than would be normal at
this stage of the cycle, to provide a signifcantly
better diversifed portfolio. Global infation-
linked debt has proved a powerfl diversifer in
the last decade, both within bond portfolios
and within balanced fnds. Holdings in this
asset class allow investors to move closer to
their efcient frontier.
With the shockwaves of the financial crisis still rumbling around the markets,
a growing theme is the divergence of inflation prospects across different
economies. Before the crisis, the degree of homogeneity of outlook was
remarkable; now, the opposite is the case.
Jonathan Gibbs,
Head of Real Returns
3 An investor’s guide to inflation-linked bonds
As the infation performance of diferent
economies has diverged in recent times, so
has the policy response. The US still has its
foot frmly on the stimulus gas, while the UK
has started stringent fscal restraint. In the
Euro-zone, the ECB remains unreconstructedly
monetarist, and the fscal picture is as varied
across the Euro-zone as is the economic
performance. We believe this divergence of
both performance and policy response will
generate opportunities.
A key example of this is the performance of
Australia, where the economy has benefted
from heavy exposure to emerging economies
such as China and India. Australian real yields
are much higher than the major markets, and
we have benefted from this several times
in our global infation portfolios. Australian
bonds have underperformed US ones in recent
months and we believe there is an opportunity
to see this reverse over time as the Australian
economy cools.
In conclusion, the divergence of economic
performance and policy response can be exploited
by managers of global fnds to add value. We
seek opportunities in both cash and derivative
markets. Global infation portfolios can form a
key part of a wider multi-asset portfolio, providing
substantial diversifcation of risk.
Basis points spread between Australian and US real yields
Source: Bloomberg as at 31 May 2011.
80
90
100
110
120
130
140
150
160
170
180
Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May
2010 2011
An investor’s guide to inflation-linked bonds 4
Some Key Concepts
The features of an inflation-linked
bond
An infation-linked bond is similar to a nominal
bond such as a Treasury bond. The only diference
is that both its principal (the fnal payment at
maturity) and its coupon (the interest rate paid
during the life of the bond) are linked to an
infation index. This means that the investor
receives the real face value of the bond at
maturity, and the real value of the interest rate
in the meantime.
Real yields
Instead of focusing on nominal yields, investors
in infation-linked bonds are interested in real
yields, which measure a bond’s yield adjusted
for infation. This measure is important because
infation erodes the real value of investment
returns on nominal bonds, and consequently
reduces an investor’s spending power in the
fture. It is also important to investors whose
liabilities are impacted by infation, as investors
will seek to retain real spending power for
the fture.
In fndamental economic terms, real yields can
be interpreted as the price of economic capital
– for example, the price that businesses have
to pay to invest in new plant and machinery. In
boom times, this price rises with the demand
for that capital, and therefore so do real yields.
Conversely, in times of weakness, real yields
fall as demand for capital falls.
Nominal yields
The yield on a nominal bond yield can be
deconstructed using what is known as the
Fisher equation. This breaks down nominal
For example, if the annual coupon of a
nominal bond was 5% and the underlying
principal of this bond was $100, the annual
coupon payment would be $5. In the case
of an infation-linked bond, if the infation
index increased by 75% over the life of
the bond, the principal of the bond would
increase to $100 x 175% = $175. The
nominal coupon rate would rise in line with
the price index over the life of the bond, and
in this instance would be 8.75% (but still 5%
in real terms) at maturity
n = r + i
Where:
n = yield on a nominal bond
r = real yield on an IL bond
of the same term maturity
i = infation expectations
yields into three components: infation
expectations, a required real yield that
investors demand over and above those
infation expectations, and a ‘risk premium’.
This last factor, which represents the price
investors are prepared to pay for a guaranteed
real return, is notoriously difcult to calculate,
and many an academic has failed to quantif
it. For this reason, the market convention
is to include risk premium within infation
expectations, resulting in the following
simplifed formula:
This equation results in one of the most
important concepts for investors. The infation
expectations element of the formula represents
the expected average level of growth in the
price level over the life of a nominal bond and
an infation-linked bond of similar maturities. By
extension, if the market is correct about these
expectations, then in order for the equation to
remain in equilibrium, the overall returns on the
two bonds must be identical. This is known as
the breakeven rate. If infation is higher than
what is priced in over the life of the bonds, the
infation-linked bond will give a higher return; if
lower, the nominal bond will perform better.
So investors who wish to take a view on the
path of infation have a choice. If they believe
that infation will be higher than the level priced
in by the market, they will sell nominal bonds
and buy infation-linked. If lower, they will do
the opposite. If of course the market is right,
the investors will breakeven.
However, this is not just a hold-to-maturity
strategy, as a breakeven rate priced by
the market represents the expected average
rate of infation over the life of the bonds.
Infation expectations vary with economic
conditions, and so by varying the weightings
of nominal and infation-linked bonds in
the portfolio, investors can take views on
movements in those expectations.
5 An investor’s guide to inflation-linked bonds
Who Issues
Inflation-Linked Bonds?
The primary issuers of infation-linked bonds
are governments. All of the G7 governments,
and many others, now use the asset class as
part of their borrowing program. The reasons
behind this are manifold, but it is done at
least in part to cheapen the cost of fnding.
Governments expect to ‘save’ the risk premium,
by guaranteeing investors a real return.
Investors are willing to pay more for this surety.
Issuing infation-linked bonds can be shown
to smooth the cashfows of a government.
A good deal of governments’ incomes are at
least partly infation-linked. Sales and value
added taxes along with excise duties are prime
examples. By matching the mix of income
and payments, a government can reduce
the volatility of its cashfows, and in theory
at least, needs to adjust its tax rates less
frequently.
Infation-linked bonds provide informational
advantages to governments and central banks
by demonstrating a market-driven, observable,
measure of infation expectations. On occasion,
this can be distorted by institutional factors,
but implied infation expectations are a usefl
tool for policy makers.
In some instances, issuing in infation-linked
space has been used as a demonstration of
a government’s infation fghting credentials.
For example, the UK launched its infation-
linked market in the early 1980s at a time of
high infation, and by taking on the infation
risk of its debt, it was demonstrating its
determination to bring infation under control.
Many governments, for example some in South
America, have found that when their infation
rates were persistently high, infation-linked
bonds were the only bonds that investors
would buy.
Issuance of infation-linked bonds can also
be seen as a means of reaching out to the
widest range of investors possible, while also
diversifing the risk of a government. In many
ways, a government can be seen as a fnd
manager with the assets and liabilities column
headings swapped over. Diversifing assets is
every bit as important as diversifing liabilities.
Non-government issuers are fairly rare outside
the UK, and are dominated by semi-government
and agency issuers such as KfW, EIB and New
South Wales Treasury Corporation. In the UK,
a number of utility companies, whose pricing
structures are statutorily linked to the Retail
Price Index, have issued infation-linked bonds.
There are also a number of Private Finance
Initiative bonds (PFI is a scheme to encourage
government sponsored infrastructure spend
without afecting the government’s balance
sheet), which were used to fnance the building
of schools and hospitals, and similarly had
infation-linked cashfows. Outside the UK,
infation markets are almost exclusively
government and semi-government issued.
An investor’s guide to inflation-linked bonds 6
Who Invests in
Inflation-Linked Bonds?
Typical investor profile
Infation-linked bonds appeal to a wide and
growing range of investors. Clearly, the ability
to match infation-linked liabilities is the prime
reason to invest. If investors’ real liabilities are
concrete, the only way to guarantee a cashfow
in real terms at that point is to buy an infation-
linked bond that matures at the same time as
the liability. Plenty of other real assets exist,
such as equities, property and commodities,
but they do not constitute an infation hedge.
They are far more volatile than the price level,
and may actually deliver a loss in real terms at
the appointed time. A mixture of real assets
will usually be a more efcient portfolio than a
single asset, and infation-linked bonds tend to
be poorly correlated with riskier real assets, so
there is considerable diversifcation advantage
to be had from adding infation-linked bonds to
the portfolio.
Investors with a portfolio of fxed real terms
liabilities may buy a matching portfolio of
infation-linked bonds. The portfolio can be
designed to closely match the liability profle.
Many more investors however opt for a less
rigid match, but look at the appropriateness
of the mix of their assets relative to liabilities.
This tends to result in investments in actively
managed, benchmark-driven portfolios of
infation-linked bonds.
The most prominent among these investors
are pension fnds. They, by defnition, have
an extensive book of real liabilities, which
they must meet at the appropriate time. An
immature pension fnd, where most of the
liabilities are a long way in the fture, can
aford to take a riskier view, holding a more
volatile range of real assets. As the fnd
matures, the risk appetite of the
fnd falls, and the need for closer liability
matching grows. This applies both to an
individual’s pension investment fnd, and to
company or institutional wholesale fnds. So
as a fnd matures, weightings in equities and
property tend to fall at the expense of infation-
linked exposure.
Charities, endowments and foundations are
also major investors in infation-linked assets,
looking to preserve capital without undue
volatility. These investors also frequently have
infation-linked payment schedules to their
benefciaries, which makes infation-linked
investments all the more suitable.
7 An investor’s guide to inflation-linked bonds
The Benefits of
Inflation-Linked Investing
In addition to the liability matching benefts
we have just discussed, infation-linked
bonds play a much wider role in both the bond
portfolio, and the total portfolio of assets.
Bondholders who expect infation expectations
to rise should increase their holdings of
infation-linked bonds, as these will outperform
nominal bonds if this occurs. Infation-linked
bonds are also less volatile than nominal
bonds, as they respond to movements in real
yields, not nominal yields. This results in a
smoothing of returns to investors. Further, if
investors perceive that nominal yields are too
low, holdings of infation-linked bonds will give
some measure of downside protection.
More importantly though, infation-linked
portfolios, and particularly global ones, ofer
signifcant levels of diversifcation within the bond
portfolio, as they have a relatively low correlation
with other bond asset classes. Within the wider
portfolio, those correlations are even lower,
meaning that a global infation-linked portfolio is
an excellent diversifer, improving risk and return
characteristics of the overall portfolio and pushing
the investor closer to his or her efcient frontier.
An investor’s guide to inflation-linked bonds 8
A Wide Opportunity Set
While the US remains the largest issuer of
infation-linked bonds, investing in global
infation-linked bonds ofers a broader
opportunity set than domestic portfolios, in
addition to giving access to the global liquidity
pool. The global market extends maturities
available for US investors from 30 to 45 years.
The chart below is a distribution by size and
maturity of bonds in the Barclays Global
Infation-Linked Index, showing the depth of the
opportunity set available. Liquidity is generally
good across the major infation-linked issuers.
Access to derivatives, while not required, widens
the opportunity set yet frther.
In addition to the reduction in risk brought about
by reducing exposure to unexpected changes
in price levels by investing in an infation-linked
portfolio, moving from a domestic portfolio to
a global portfolio reduces the risk yet frther
as no one country will determine the success
or failure of your investment portfolio. The
expanded opportunity set also ofers a broader
opportunity set than a purely domestic portfolio.
Barclays Global Infation-Linked Index
M
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UK US Euro-zone Canada Australia Sweden Japan
9 An investor’s guide to inflation-linked bonds
Reducing risks
The chart below suggests very strongly that a portfolio of hedged global infation-linked bonds
is much more efcient than a simple domestic one, displaying signifcantly better risk-return
characteristics. Similar results are generated against other bond asset classes, and even greater
diversifcation benefts are shown against asset classes in the wider portfolio.
Active Versus Passive Investment
We believe that the infation-linked bond
markets are inefcient, and this creates an
opportunity for active investment managers to
outperform those that adopt a passive strategy.
Because infation-linked bonds represent a
relatively small proportion of the global bond
market, there is relatively limited research
undertaken. Markets are localised, and diferent
markets are afected by diferent drivers.
Adopting a passive strategy commits investors
to abide by whatever the rules of the passive
benchmark are, however bad. For example,
an issuing country may underperform very
substantially before being ejected from a
benchmark index, damaging returns to passive
investors. Active investors can anticipate such
changes and create outperformance. This was
the case when Greek infation-linked bonds
were ejected from the benchmark indices at
the end of 2009. Passive investors will have
been forced to sell at the end of the year
when Greece dropped out of the benchmark.
Active investors had the ability to reduce their
exposure well in advance of this. Passive
investing ensures that investors will fall into
every pitfall along the way, whereas active
investing allows the manager to help investors
to avoid them.
Efcient Frontier: World Govt Infation-Linked All Maturities vs iBoxx Dollar
Corporates BBB
Source: Datastream and Barclays Capital: 29/12/2000 - 31/12/2010
Best Risk Adjusted Return
100% World Govt
Infation-Linked
All Maturities
Minimum Risk Portfolio
100% US Govt Infation-Linked All Maturities
6.0
6.5
7.0
7.5
8.0
8.5
6.5 7.0 7.5 8.0 8.5 9.0
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Risk%
An investor’s guide to inflation-linked bonds 10
Holding a global portfolio of course introduces
exposure to the infation rates of other
countries, and therefore a mismatch in returns.
However, in a diversifed global portfolio, so
long as the currency exposure is hedged back
to the domestic currency, the mismatch should
be small over time.
This relies on the concept that countries with
higher infation tend to have higher interest
rates. This will mean that over the cycle the
carry on the foreign exchange hedge will ofset
the infation mismatch.
For example, an investor in a higher infation,
higher interest rate economy buys infation-linked
bonds in a lower infation, lower interest rate
economy. The bonds will provide insufcient uplif
to match his domestic infation, but the interest
rate diferential will mean there is a positive carry
on the foreign exchange hedge, and these two
should, over the medium term, net out.
These relationships are not perfect and do not
work instantaneously, but a well diversifed,
hedged global portfolio of infation-linked
bonds should, over the medium term, be an
efective domestic infation-linked asset.
Managing Currency Risk in a
Global Inflation Portfolio
11 An investor’s guide to inflation-linked bonds
A global market in government infation-linked
bonds has only really existed since around
the turn of the millennium. The UK was the
frst major issuer in 1981, and for some time
it was a small corner of the world markets,
present in just the UK, Canada and Australia.
When the US launched its Treasury Infation
Protected Securities (TIPS) program in 1997,
the global market began to emerge. Euro-zone
issuers followed, with France issuing bonds
indexed both to French infation (OATi) and
Euro-zone infation (OATei), and Italy, Greece
and eventually Germany following in Euro-
zone-linked bonds. Japan completed the list
of G7 issuers in 2004, and Sweden is also a
large enough issuer to gain entry to market
benchmark indices.
The chart below shows the growth in the
market value over time, showing that recent
years have seen a massive increase in both
supply and demand.
The TIPS market has, unsurprisingly, surpassed
all others in terms of size, representing 39%
of the Barclays Global Infation-Linked Index.
The Euro-zone has grown to 19% of bonds
outstanding. Australia returned to issuance in
the autumn of 2009, with a A$4bn issue (the
largest bond issue in Australia ever).
Barclays Global Index – Infation-Linked Bonds Market Value ($bn)
Source: Barclays Capital. Data as at 31 March 2011.
0
200
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1000
1200
1400
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1800
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
US UK Sweden Japan Italy Germany France Canada Australia
A brief History of
Inflation-Linked Markets
An investor’s guide to inflation-linked bonds 12
Other issuers
Many other countries issue infation-linked
bonds, but are too small a size or too poor
a credit rating to enter mainstream indices.
Many countries at one stage could only issue
in infation-linked bonds, as investors would
not buy nominal assets of countries with weak
currencies and persistent high infation. Brazil
is the prime example of this, and represents
a large proportion of the emerging market
infation-linked index.
Brazil has a long history in government
infation-linked bonds, its frst issue dating
back to 1964. It is the largest emerging market
issuer with over $130bn market value.
EM Infation-Linked Bonds Market Value ($bn)
0
50
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150
200
250
300
350
400
450
500
1996 1998 2000 2002 2004 2006 2008 2010
Israel
Source: Barclays Capital. Data as at 31 March 2011.
Turkey Poland Mexico South Korea Colombia Brazil Argentina Chile South Africa
Infation-Linked Bonds Outstanding by Market Value ($bn)
0
100
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Source: Barclays Capital. Data as at 31 March 2011.
13 An investor’s guide to inflation-linked bonds
Party A Party B
Infation
Fixed Rate
As the size and sophistication of the global
infation market has expanded, a range of
infation derivative products has arrived to
broaden the opportunity set frther. The
market for infation swaps ofers investors an
alternative means of expressing their views
on infation.
In each region, the infation swap market uses
the index to which domestic bond markets are
linked. The most common structure of infation
There are active infation swap markets in the
UK, US, Euro-zone, France, Australia and Japan.
There are also less developed markets in
Sweden and Canada but activity is very light.
The infation swap market and infation-linked
bond markets ofen interact via asset swap
activity (whereby an investor can pay infation-
linked bond cashfows to a counterparty in
exchange for LIBOR fows). The more active
swap markets also have their own liquidity.
Supply tends to come from corporate bond
issuance, structured medium-term notes or
retail savings products linked to infation.
Demand comes from pension fnds (especially
in the UK and a growing theme in Europe), real
money and leveraged investors.
swap traded is a zero coupon swap, where
there is just one cashfow in each direction
at maturity. In the example below, Party B
pays a fxed amount, agreed at inception, and
receives an amount linked to the growth in the
relevant infation index over the life of the swap.
Therefore, if the price level rises by more than
the fxed amount, party B makes a proft on the
swap. The value of the swap at any given point in
its life is determined by movements in infation
expectations since the inception of the trade.
The zero coupon nature of infation swaps
makes it an efcient way of implementing a
view or hedging an exposure on a particular
part of the curve without worrying about any
cashfows prior to maturity that can be an issue
when using bonds.
Infation swaps are now used by a wide variety of
investors, for matching and hedging purposes,
as well as in conjunction with bond markets to
create more efcient portfolios. It should be noted
though that a long term infation swap does not
guarantee a cashfow; if one’s swap counterparty
ceases to exist, so does the swap. Swaps are
collateralized (typically daily) such that the current
market value of a swap is protected, but the actual
pay-out should not be seen as equivalent in risk to
a government bond.
The Role of Inflation Swaps
An investor’s guide to inflation-linked bonds 14
Major issuers and their corresponding indices are shown in the table below:
Key global infation indices
Country Issue Issuer Infation index
United States

Treasury Infation-
Protected Securities
(TIPS)
US Treasury

US Consumer Price
Index (NSA)
United Kingdom Infation-linked Gilt UK Debt Management
Ofce
Retail Price Index
Japan JGBi Ministry of Finance Japan CPI
Germany

Bund index and BO
index

Bundesrepublik
Deutschland
Finanzagentur
EU HICP ex Tobacco

France
OATi and OATei
Agence France Tresor France CPI ex-tobacco
(OATi), EU HICP (OATei)
Canada Real Return Bond Bank of Canada Canada All-items CPI
Australia Capital Indexed Bonds Department of the
Treasury (Australia)
ACPI
Sweden Index-linked treasury
bonds
Swedish National Debt
Ofce
Swedish CPI
Italy BTP€i Department of the
Treasury
EU HICP ex Tobacco
Key Global Inflation Indices
15 An investor’s guide to inflation-linked bonds
Looking Ahead
The growth of the market is set to continue
across many countries:
¬ The investment grade market has grown from
$1454 billion at the end of 2009 to $1703
billion at the end of Q1 2011. There has
been new issuance from all countries in the
benchmark index except Japan, where the
Ministry of Finance continues to buy back
existing bonds.
¬ The US TIPS market has increased
signifcantly in size (from $563 billion at the
end of 2009 to $677 billion at the end of Q1
2011) and maturity.
¬ The UK RPI-linked market increased from
$341 billion at the end of 2009 to $406
billion at the end of Q1 2011, primarily
driven by very long-dated bonds sought
afer by pension fnds. In addition, there
are expectations for a CPI market to develop
over the next few years afer the Secretary
of State for pensions announced in July 2010
that UK pension indexation will switch to
CPI from RPI.
¬ Since 2009, the Australian market has almost
doubled in size, from $10.5 billion to $19.1
billion at end of Q1 2011. The longest maturity
has increased from 2025 to 2030. New Zealand
is expected to re-enter the market in 2011
although timing remains uncertain.
¬ European issuance has also grown, across
Germany, France and Italy, from $394 billion
at the end of 2009 to $457 billion at the end
of Q1 2011. Germany is expected to expand
the maturity range of its bonds in the near
fture by issuing a 30-year bond, and there
are ongoing rumours of issuance in the
pipeline from Ireland and Spain, although
this may be subject to prevailing sentiment
in peripheral European bond markets.
¬ Infation continues to be a highly important
topic in emerging markets and the stock of
infation-linked bonds has grown rapidly. The
Brazilian, Mexican and Polish markets have
all increased in nominal size by over 70%
since the end of 2009 (equating to nominal
growth of $97 billion, $21 billion and $3
billion respectively).
An investor’s guide to inflation-linked bonds 16
Contact Details
For more information, please contact a member
of our team.
Visit us online
standardlifeinvestments.com
Michael De Vere
Investment Director - Asia
Tel +82 (0) 2 3782 4765
michael_devere@standardlife.com
David Peng
Investment Director
Head of Business Development - China, Taiwan, Hong Kong
Tel +852 9388 5285
david_peng@standardlife.com
Hong Ji
Chief Representative
Beijing
Tel +86 10 84193401
hong_ji@standardlife.com
20 An investor’s guide to inflation-linked bonds
standardlifeinvestments.com
Standard Life Investments (Hong Kong) Limited is licensed with and regulated by the Securities and Futures Commission in Hong Kong and is a wholly-
owned subsidiary of Standard Life Investments Limited. Standard Life Investments Limited is registered in Scotland (SC123321) at 1 George Street,
Edinburgh EH2 2LL. Standard Life Investments are authorised and regulated by the Financial Services Authority.
Calls may be monitored and/or recorded to protect both you and us and help with our training.
www.standardlifeinvestments.com © [2011] Standard Life, images reproduced under licence
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Standard Life Investments is a premier asset manager with an expanding global reach. Our wide range of investment solutions is backed by our distinctive Focus on Change investment philosophy, disciplined risk management and shared commitment to a culture of investment excellence.

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An investor’s guide to inflation-linked bonds

Contents 1 2 4 5 6 7 8 About Standard Life Investments Diverging Inflation Paths Create Opportunities Some Key Concepts Who Issues Inflation-Linked Bonds? Who Invests in Inflation-Linked Bonds? The Benefits of Inflation-Linked Investing A Wide Opportunity Set 10 Managing Currency Risk in a Global Portfolio 11 A Brief History of Inflation-Linked Markets 13 The Role of Inflation Swaps 14 Key Global Inflation Indices 15 Looking Ahead 16 Contact Details .

Beijing. Our parent. They include corporate pension plans. Our investors rank among some of the world’s most sophisticated and high-profile institutions.About Standard Life Investments Standard Life Investments is a premier asset manager with an expanding global reach. As at 31 December 2010. Montreal. Standard Life floated on the London Stock Exchange in 2006 and is now a FTSE 100-listed company. disciplined risk management and shared commitment to a culture of investment excellence. London. Sydney. multi-asset solutions. Dublin. ensuring that our clients can look to the future with confidence. we have close relationships with leading domestic players in Asia. Our wide range of investment solutions is backed by our distinctive Focus on Change investment philosophy. A leading provider of long-term savings and investments. Standard Life Investments managed $245.6 billion on behalf of clients worldwide. sovereign wealth funds and government authorities. As active managers. 1 An investor’s guide to inflation-linked bonds . official institutions. banks. Paris and Seoul. mutual funds. Our investment capabilities span equities. We constantly think ahead and strive to anticipate change before it happens. including HDFC Asset Management in India and Chuo Mitsui Asset Trust and Banking in Japan. We maintain offices in a number of locations around the world including Boston. Standard Life Investments was launched as a separate company in 1998 and has quickly established a reputation for innovation in pursuit of our clients’ investment objectives. fund-of-funds and absolute return strategies. insurance companies. we place significant emphasis on rigorous research and a strong collaborative ethos. real estate. private equity. Hong Kong. In addition. fund-of-fund managers. Headquartered in Edinburgh. charities. foundations. endowments. fixed income. Standard Life Investments employs more than 850 talented professionals. Standard Life plc. was established in 1825.

In recent months.e. Hence. Jonathan Gibbs. Indeed. led by Germany where some wage pressures are starting to appear. Core Europe has recovered well from the crisis. Questions have to be asked therefore about why inflation insurance is no more expensive now than then. This may mean a greater weight in inflation-linked bonds. While such divergence may complicate matters for policy makers. the degree of homogeneity of outlook was remarkable. the plight of the peripheral EMU countries needs little further description. yet only the US displays the classic symptoms. However inflation expectations over the coming five years are only at comparable levels to those experienced prior to the crisis. In that period. Holdings in this asset class allow investors to move closer to their efficient frontier. This move has been highly correlated with the changes in the price of oil and other major commodities. both within bond portfolios and within balanced funds. through one where deflation was seen as much more of a threat. and even when capacity utilisation indicators are largely around cyclical averages rather than at peak levels. Inflation is diverging Having emerged from a period where the world generally thought inflation was tamed. this creates a further degree of difference. permanently. with the Fed still easing quantitatively. Head of Real Returns In the 1990s-2000s. the inflation path has looked rather different from one economy to another. now known as the Great Moderation. those with an implicit or explicit link to inflation. However. An investor’s guide to inflation-linked bonds 2 . The UK’s inflation data has stubbornly exceeded expectations ever since the crisis. whereas in the US core inflation has tracked obdurately lower. In recent years. Before the crisis. now. Global inflationlinked debt has proved a powerful diversifier in the last decade. Policy makers in both countries allege the existence of large output gaps. even when all of the temporary factors such as tax increases and the impact of a lower currency are removed. Compare. At this stage of the economic cycle. a noticeable feature of the economic landscape was that inflation was low across most countries despite consistently strong economic growth. but it is not at levels implied by output gap estimates. given the much higher existing levels of uncertainty. the upswing in inflation pressures. In the UK. partly in the US and Europe but especially across many emerging market economies. the opposite is the case. the Bank of England split on the timing of a tightening and the ECB chairman making it abundantly clear that action is coming soon. i. Inflation is stubbornly higher than it should be. we would expect in normal circumstances that investors should favour real assets. The dilemma for the ECB in terms of policy making is plain to see. after a far from normal recession. this is far from a normal recovery. inflation expectations have risen markedly across major markets. for example.Diverging Inflation Paths Create Opportunities With the shockwaves of the financial crisis still rumbling around the markets. to provide a significantly better diversified portfolio. it is expected that investors will wish to own a more cautious mix of real assets than in more normal circumstances. Similarly for Europe. Conversely. and lower weightings in riskier real assets than would be normal at this stage of the cycle. has brought inflation-linked bonds to the forefront of many investment discussions. it does throw up opportunities for investors to add value in bond portfolios. the US and the UK. a growing theme is the divergence of inflation prospects across different economies. the consensus was that the authorities had inflation under control. unemployment may be high. there is a marked heterogeneity of economic performance.

providing substantial diversification of risk. so has the policy response. and the fiscal picture is as varied across the Euro-zone as is the economic performance. and we have benefited from this several times in our global inflation portfolios. 3 An investor’s guide to inflation-linked bonds . In conclusion. We believe this divergence of both performance and policy response will generate opportunities. In the Euro-zone. the divergence of economic performance and policy response can be exploited by managers of global funds to add value. We seek opportunities in both cash and derivative markets. Global inflation portfolios can form a key part of a wider multi-asset portfolio. the ECB remains unreconstructedly monetarist. Australian real yields are much higher than the major markets.As the inflation performance of different economies has diverged in recent times. Basis points spread between Australian and US real yields 180 170 160 150 140 130 120 110 100 90 80 Jun Jul Aug Sep 2010 Oct Nov Dec Jan Feb Mar 2011 Apr May Source: Bloomberg as at 31 May 2011. Australian bonds have underperformed US ones in recent months and we believe there is an opportunity to see this reverse over time as the Australian economy cools. where the economy has benefited from heavy exposure to emerging economies such as China and India. A key example of this is the performance of Australia. while the UK has started stringent fiscal restraint. The US still has its foot firmly on the stimulus gas.

Real yields Instead of focusing on nominal yields. investors can take views on movements in those expectations. the investors will breakeven. real yields fall as demand for capital falls. real yields can be interpreted as the price of economic capital – for example. This last factor. the inflation-linked bond will give a higher return. In fundamental economic terms. the overall returns on the two bonds must be identical. The nominal coupon rate would rise in line with the price index over the life of the bond. In the case of an inflation-linked bond. If of course the market is right. This breaks down nominal An investor’s guide to inflation-linked bonds 4 . in times of weakness. this price rises with the demand for that capital. For example. resulting in the following simplified formula: n=r+i Where: n= yield on a nominal bond r= real yield on an IL bond of the same term maturity i= inflation expectations This equation results in one of the most important concepts for investors. which represents the price investors are prepared to pay for a guaranteed real return. the principal of the bond would increase to $100 x 175% = $175. Inflation expectations vary with economic conditions. The only difference is that both its principal (the final payment at maturity) and its coupon (the interest rate paid during the life of the bond) are linked to an inflation index. investors in inflation-linked bonds are interested in real yields. The inflation expectations element of the formula represents the expected average level of growth in the price level over the life of a nominal bond and an inflation-linked bond of similar maturities. the annual coupon payment would be $5. In boom times. if the annual coupon of a nominal bond was 5% and the underlying principal of this bond was $100. this is not just a hold-to-maturity strategy.75% (but still 5% in real terms) at maturity yields into three components: inflation expectations. If they believe that inflation will be higher than the level priced in by the market. they will sell nominal bonds and buy inflation-linked. then in order for the equation to remain in equilibrium. It is also important to investors whose liabilities are impacted by inflation. the market convention is to include risk premium within inflation expectations. By extension. If lower. is notoriously difficult to calculate.Some Key Concepts The features of an inflation-linked bond An inflation-linked bond is similar to a nominal bond such as a Treasury bond. For this reason. However. the price that businesses have to pay to invest in new plant and machinery. If inflation is higher than what is priced in over the life of the bonds. and the real value of the interest rate in the meantime. This means that the investor receives the real face value of the bond at maturity. they will do the opposite. as a breakeven rate priced by the market represents the expected average rate of inflation over the life of the bonds. which measure a bond’s yield adjusted for inflation. and a ‘risk premium’. if the market is correct about these expectations. the nominal bond will perform better. and therefore so do real yields. a required real yield that investors demand over and above those inflation expectations. as investors will seek to retain real spending power for the future. This measure is important because inflation erodes the real value of investment returns on nominal bonds. if the inflation index increased by 75% over the life of the bond. So investors who wish to take a view on the path of inflation have a choice. Nominal yields The yield on a nominal bond yield can be deconstructed using what is known as the Fisher equation. and in this instance would be 8. This is known as the breakeven rate. and many an academic has failed to quantify it. and consequently reduces an investor’s spending power in the future. Conversely. and so by varying the weightings of nominal and inflation-linked bonds in the portfolio. if lower.

In some instances. Diversifying assets is every bit as important as diversifying liabilities. whose pricing structures are statutorily linked to the Retail Price Index. inflation-linked bonds were the only bonds that investors would buy.Who Issues Inflation-Linked Bonds? The primary issuers of inflation-linked bonds are governments. and many others. The reasons behind this are manifold. On occasion. EIB and New South Wales Treasury Corporation. a government can reduce the volatility of its cashflows. A good deal of governments’ incomes are at least partly inflation-linked. Sales and value added taxes along with excise duties are prime examples. 5 An investor’s guide to inflation-linked bonds . but it is done at least in part to cheapen the cost of funding. For example. observable. have issued inflation-linked bonds. and are dominated by semi-government and agency issuers such as KfW. All of the G7 governments. Issuance of inflation-linked bonds can also be seen as a means of reaching out to the widest range of investors possible. Many governments. inflation markets are almost exclusively government and semi-government issued. while also diversifying the risk of a government. for example some in South America. Investors are willing to pay more for this surety. which were used to finance the building of schools and hospitals. Governments expect to ‘save’ the risk premium. the UK launched its inflationlinked market in the early 1980s at a time of high inflation. and similarly had inflation-linked cashflows. issuing in inflation-linked space has been used as a demonstration of a government’s inflation fighting credentials. this can be distorted by institutional factors. now use the asset class as part of their borrowing program. Non-government issuers are fairly rare outside the UK. have found that when their inflation rates were persistently high. and by taking on the inflation risk of its debt. by guaranteeing investors a real return. a number of utility companies. Outside the UK. In many ways. There are also a number of Private Finance Initiative bonds (PFI is a scheme to encourage government sponsored infrastructure spend without affecting the government’s balance sheet). needs to adjust its tax rates less frequently. Inflation-linked bonds provide informational advantages to governments and central banks by demonstrating a market-driven. By matching the mix of income and payments. measure of inflation expectations. a government can be seen as a fund manager with the assets and liabilities column headings swapped over. but implied inflation expectations are a useful tool for policy makers. In the UK. and in theory at least. Issuing inflation-linked bonds can be shown to smooth the cashflows of a government. it was demonstrating its determination to bring inflation under control.

weightings in equities and property tend to fall at the expense of inflationlinked exposure. and may actually deliver a loss in real terms at the appointed time. property and commodities. but they do not constitute an inflation hedge. the ability to match inflation-linked liabilities is the prime reason to invest. so there is considerable diversification advantage to be had from adding inflation-linked bonds to the portfolio. such as equities.Who Invests in Inflation-Linked Bonds? Typical investor profile Inflation-linked bonds appeal to a wide and growing range of investors. looking to preserve capital without undue volatility. An immature pension fund. Many more investors however opt for a less rigid match. Charities. An investor’s guide to inflation-linked bonds 6 . where most of the liabilities are a long way in the future. which makes inflation-linked investments all the more suitable. can afford to take a riskier view. benchmark-driven portfolios of inflation-linked bonds. have an extensive book of real liabilities. They are far more volatile than the price level. This applies both to an individual’s pension investment fund. These investors also frequently have inflation-linked payment schedules to their beneficiaries. Plenty of other real assets exist. Investors with a portfolio of fixed real terms liabilities may buy a matching portfolio of inflation-linked bonds. As the fund matures. but look at the appropriateness of the mix of their assets relative to liabilities. A mixture of real assets will usually be a more efficient portfolio than a single asset. the risk appetite of the fund falls. which they must meet at the appropriate time. The portfolio can be designed to closely match the liability profile. holding a more volatile range of real assets. So as a fund matures. If investors’ real liabilities are concrete. endowments and foundations are also major investors in inflation-linked assets. and inflation-linked bonds tend to be poorly correlated with riskier real assets. the only way to guarantee a cashflow in real terms at that point is to buy an inflationlinked bond that matures at the same time as the liability. They. by definition. This tends to result in investments in actively managed. and the need for closer liability matching grows. and to company or institutional wholesale funds. The most prominent among these investors are pension funds. Clearly.

7 An investor’s guide to inflation-linked bonds . and the total portfolio of assets. offer significant levels of diversification within the bond portfolio. More importantly though. inflation-linked portfolios. those correlations are even lower. Within the wider portfolio. as they respond to movements in real yields. as they have a relatively low correlation with other bond asset classes. as these will outperform nominal bonds if this occurs. meaning that a global inflation-linked portfolio is an excellent diversifier. holdings of inflation-linked bonds will give some measure of downside protection. and particularly global ones. not nominal yields. Further. Inflation-linked bonds are also less volatile than nominal bonds. Bondholders who expect inflation expectations to rise should increase their holdings of inflation-linked bonds. inflation-linked bonds play a much wider role in both the bond portfolio.The Benefits of Inflation-Linked Investing In addition to the liability matching benefits we have just discussed. if investors perceive that nominal yields are too low. improving risk and return characteristics of the overall portfolio and pushing the investor closer to his or her efficient frontier. This results in a smoothing of returns to investors.

showing the depth of the opportunity set available. moving from a domestic portfolio to a global portfolio reduces the risk yet further as no one country will determine the success or failure of your investment portfolio. In addition to the reduction in risk brought about by reducing exposure to unexpected changes in price levels by investing in an inflation-linked portfolio. Access to derivatives. The chart below is a distribution by size and maturity of bonds in the Barclays Global Inflation-Linked Index. 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 2040 2041 2042 2043 2044 2045 2046 2047 2048 2049 2050 2051 2052 2053 2054 2055 UK US Euro-zone Canada Australia Sweden Japan 0 An investor’s guide to inflation-linked bonds 8 . investing in global inflation-linked bonds offers a broader opportunity set than domestic portfolios. while not required. The expanded opportunity set also offers a broader opportunity set than a purely domestic portfolio. widens the opportunity set yet further. in addition to giving access to the global liquidity pool. The global market extends maturities available for US investors from 30 to 45 years. Barclays Global Inflation-Linked Index 80 70 60 Market Value ($ billion) 50 40 30 20 10 Source: Bloomberg as at 31 March 2011.A Wide Opportunity Set While the US remains the largest issuer of inflation-linked bonds. Liquidity is generally good across the major inflation-linked issuers.

Active investors can anticipate such changes and create outperformance.0 100% World Govt Inflation-Linked All Maturities 7. Markets are localised. Efficient Frontier: World Govt Inflation-Linked All Maturities vs iBoxx Dollar Corporates BBB 8.0 8. damaging returns to passive investors.0 Best Risk Adjusted Return 6. Passive investing ensures that investors will fall into every pitfall along the way.0 7.5 Risk% 8. Passive investors will have been forced to sell at the end of the year when Greece dropped out of the benchmark.0 Source: Datastream and Barclays Capital: 29/12/2000 . Similar results are generated against other bond asset classes. and this creates an opportunity for active investment managers to outperform those that adopt a passive strategy. displaying significantly better risk-return characteristics.Reducing risks The chart below suggests very strongly that a portfolio of hedged global inflation-linked bonds is much more efficient than a simple domestic one. This was the case when Greek inflation-linked bonds were ejected from the benchmark indices at the end of 2009. an issuing country may underperform very substantially before being ejected from a benchmark index. Active investors had the ability to reduce their exposure well in advance of this. For example. 9 An investor’s guide to inflation-linked bonds .5 7.0 6.5 Minimum Risk Portfolio 100% US Govt Inflation-Linked All Maturities 6. however bad.31/12/2010 Active Versus Passive Investment We believe that the inflation-linked bond markets are inefficient. Because inflation-linked bonds represent a relatively small proportion of the global bond market. and even greater diversification benefits are shown against asset classes in the wider portfolio.5 Return% 7. there is relatively limited research undertaken.5 9. Adopting a passive strategy commits investors to abide by whatever the rules of the passive benchmark are. and different markets are affected by different drivers. whereas active investing allows the manager to help investors to avoid them.5 8.

and therefore a mismatch in returns. an investor in a higher inflation. over the medium term. higher interest rate economy buys inflation-linked bonds in a lower inflation. the mismatch should be small over time. The bonds will provide insufficient uplift to match his domestic inflation. be an effective domestic inflation-linked asset. lower interest rate economy. However. This relies on the concept that countries with higher inflation tend to have higher interest rates. but a well diversified. and these two should. net out. but the interest rate differential will mean there is a positive carry on the foreign exchange hedge.Managing Currency Risk in a Global Inflation Portfolio Holding a global portfolio of course introduces exposure to the inflation rates of other countries. For example. over the medium term. This will mean that over the cycle the carry on the foreign exchange hedge will offset the inflation mismatch. An investor’s guide to inflation-linked bonds 10 . in a diversified global portfolio. hedged global portfolio of inflation-linked bonds should. so long as the currency exposure is hedged back to the domestic currency. These relationships are not perfect and do not work instantaneously.

and Italy. The UK was the first major issuer in 1981.A brief History of Inflation-Linked Markets A global market in government inflation-linked bonds has only really existed since around the turn of the millennium. showing that recent years have seen a massive increase in both supply and demand. Australia returned to issuance in the autumn of 2009. The TIPS market has. Japan completed the list of G7 issuers in 2004. The Euro-zone has grown to 19% of bonds outstanding. 11 An investor’s guide to inflation-linked bonds . and Sweden is also a large enough issuer to gain entry to market benchmark indices. representing 39% of the Barclays Global Inflation-Linked Index. When the US launched its Treasury Inflation Protected Securities (TIPS) program in 1997. the global market began to emerge. with a A$4bn issue (the largest bond issue in Australia ever). Barclays Global Index – Inflation-Linked Bonds Market Value ($bn) 1800 1600 1400 1200 1000 800 600 400 200 0 1996 UK 1997 1998 1999 Japan 2000 Italy 2001 Germany 2002 2003 2004 Canada 2005 2006 2007 2008 2009 2010 US Sweden France Australia Source: Barclays Capital. present in just the UK. Data as at 31 March 2011. and for some time it was a small corner of the world markets. unsurprisingly. The chart below shows the growth in the market value over time. surpassed all others in terms of size. Euro-zone issuers followed. Greece and eventually Germany following in Eurozone-linked bonds. Canada and Australia. with France issuing bonds indexed both to French inflation (OATi) and Euro-zone inflation (OATei).

Israel 0 An investor’s guide to inflation-linked bonds 12 . its first issue dating back to 1964. It is the largest emerging market issuer with over $130bn market value. Inflation-Linked Bonds Outstanding by Market Value ($bn) 800 700 600 500 400 300 200 100 Sweden Poland Japan Australia Argentina Germany Canada South Africa South Korea Colombia Mexico France Greece Turkey Italy UK US Chile Brazil Source: Barclays Capital. and represents a large proportion of the emerging market inflation-linked index. but are too small a size or too poor a credit rating to enter mainstream indices. Many countries at one stage could only issue in inflation-linked bonds. EM Inflation-Linked Bonds Market Value ($bn) 500 450 400 350 300 250 200 150 100 50 0 1996 Israel 1998 Turkey Poland 2000 Mexico 2002 South Korea 2004 Colombia Brazil 2006 Argentina 2008 Chile 2010 South Africa Source: Barclays Capital. Data as at 31 March 2011.Other issuers Many other countries issue inflation-linked bonds. Data as at 31 March 2011. Brazil is the prime example of this. as investors would not buy nominal assets of countries with weak currencies and persistent high inflation. Brazil has a long history in government inflation-linked bonds.

so does the swap. US. where there is just one cashflow in each direction at maturity. France. Inflation Party A Party B Fixed Rate There are active inflation swap markets in the UK. 13 An investor’s guide to inflation-linked bonds . Inflation swaps are now used by a wide variety of investors. Therefore. Supply tends to come from corporate bond issuance. if the price level rises by more than the fixed amount. as well as in conjunction with bond markets to create more efficient portfolios. Euro-zone. There are also less developed markets in Sweden and Canada but activity is very light. real money and leveraged investors. party B makes a profit on the swap. and receives an amount linked to the growth in the relevant inflation index over the life of the swap. if one’s swap counterparty ceases to exist. Demand comes from pension funds (especially in the UK and a growing theme in Europe). Australia and Japan. the inflation swap market uses the index to which domestic bond markets are linked. In each region. The value of the swap at any given point in its life is determined by movements in inflation expectations since the inception of the trade. agreed at inception. but the actual pay-out should not be seen as equivalent in risk to a government bond. Swaps are collateralized (typically daily) such that the current market value of a swap is protected. In the example below. The inflation swap market and inflation-linked bond markets often interact via asset swap activity (whereby an investor can pay inflationlinked bond cashflows to a counterparty in exchange for LIBOR flows). Party B pays a fixed amount. The more active swap markets also have their own liquidity. structured medium-term notes or retail savings products linked to inflation. for matching and hedging purposes. The zero coupon nature of inflation swaps makes it an efficient way of implementing a view or hedging an exposure on a particular part of the curve without worrying about any cashflows prior to maturity that can be an issue when using bonds. It should be noted though that a long term inflation swap does not guarantee a cashflow. The market for inflation swaps offers investors an alternative means of expressing their views on inflation.The Role of Inflation Swaps As the size and sophistication of the global inflation market has expanded. The most common structure of inflation swap traded is a zero coupon swap. a range of inflation derivative products has arrived to broaden the opportunity set further.

EU HICP (OATei) Canada All-items CPI ACPI Swedish CPI EU HICP ex Tobacco An investor’s guide to inflation-linked bonds 14 .Key Global Inflation Indices Major issuers and their corresponding indices are shown in the table below: Key global inflation indices Country United States Issue Treasury InflationProtected Securities (TIPS) Inflation-linked Gilt JGBi Bund index and BO index Issuer US Treasury Inflation index US Consumer Price Index (NSA) Retail Price Index Japan CPI EU HICP ex Tobacco United Kingdom Japan Germany UK Debt Management Office Ministry of Finance Bundesrepublik Deutschland Finanzagentur Agence France Tresor Bank of Canada Department of the Treasury (Australia) Swedish National Debt Office Department of the Treasury France Canada Australia Sweden Italy OATi and OATei Real Return Bond Capital Indexed Bonds Index-linked treasury bonds BTP€i France CPI ex-tobacco (OATi).

¬ Since 2009. where the Ministry of Finance continues to buy back existing bonds. France and Italy. ¬ The US TIPS market has increased significantly in size (from $563 billion at the end of 2009 to $677 billion at the end of Q1 2011) and maturity. the Australian market has almost doubled in size. ¬ European issuance has also grown. There has been new issuance from all countries in the benchmark index except Japan.Looking Ahead The growth of the market is set to continue across many countries: ¬ The investment grade market has grown from $1454 billion at the end of 2009 to $1703 billion at the end of Q1 2011. although this may be subject to prevailing sentiment in peripheral European bond markets.5 billion to $19. from $10. primarily driven by very long-dated bonds sought after by pension funds.1 billion at end of Q1 2011. Germany is expected to expand the maturity range of its bonds in the near future by issuing a 30-year bond. The longest maturity has increased from 2025 to 2030. New Zealand is expected to re-enter the market in 2011 although timing remains uncertain. from $394 billion at the end of 2009 to $457 billion at the end of Q1 2011. In addition. ¬ Inflation continues to be a highly important topic in emerging markets and the stock of inflation-linked bonds has grown rapidly. $21 billion and $3 billion respectively). 15 An investor’s guide to inflation-linked bonds . and there are ongoing rumours of issuance in the pipeline from Ireland and Spain. there are expectations for a CPI market to develop over the next few years after the Secretary of State for pensions announced in July 2010 that UK pension indexation will switch to CPI from RPI. The Brazilian. Mexican and Polish markets have all increased in nominal size by over 70% since the end of 2009 (equating to nominal growth of $97 billion. ¬ The UK RPI-linked market increased from $341 billion at the end of 2009 to $406 billion at the end of Q1 2011. across Germany.

com David Peng Investment Director Head of Business Development .Asia Tel +82 (0) 2 3782 4765 michael_devere@standardlife.Contact Details For more information.com Visit us online standardlifeinvestments. Hong Kong Tel +852 9388 5285 david_peng@standardlife.China.com Hong Ji Chief Representative Beijing Tel +86 10 84193401 hong_ji@standardlife. Taiwan. Michael De Vere Investment Director .com An investor’s guide to inflation-linked bonds 16 . please contact a member of our team.

com © [2011] Standard Life. Standard Life Investments are authorised and regulated by the Financial Services Authority. images reproduced under licence .com 20 Standard Life Investments (Hong Kong) Limited is licensed with and regulated by the Securities and Futures Commission in Hong Kong and is a whollyowned subsidiary of Standard Life Investments Limited. An be monitored guide to inflation-linked and us Calls may investor’s and/or recorded to protect both youbondsand help with our training. Edinburgh EH2 2LL.standardlifeinvestments. www. Standard Life Investments Limited is registered in Scotland (SC123321) at 1 George Street.standardlifeinvestments.

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