Inflation-linked bonds “risk-free”

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Investing in inflation-linked bonds is the only sure way to protect the value of your investments during a period of high inflation and low growth, a fund manager says.

Friday, September 7th 2012, 8:51AM 1 Comment

by Niko Kloeten

Ben Alexander, a New Zealander who co-founded Australia-based Ardea Investment Management, told the Institute of Financial Professionals (INFINZ) conference this week that "breakout" inflation is a possibility investors need to be prepared for but are complacent about due to recent history.

One of the reasons higher inflation is likely, he said, is due to the quantitative easing taking place in a number of countries including the United States.

"Quantitative easing is printing money in almost a literal sense because the money supply expands to buy bonds out of the market," he said.

"The big thing it comes down to is what's the purpose of buying those bonds?  Usually the plan is to buy them and hold them then sell them when the economy recovers.  But will the economies recover to a sufficient extent to allow them to be sold on the market?"

Alexander said another reason inflation was likely to increase was due to countries lifting the inflation targets of their reserve banks; a recent report by the IMF said that 2% may be too low and that 4% would be better.

"While the inflation targeting regime had lots of benefits and was very successful, there are questions as to its current form going forward."

He said during periods of high growth and high inflation asset classes such as property, commodities and other real assets did well but during a period of high inflation and low growth inflation-linked bonds were the best option.

Risk, he said, should be defined as not increasing the purchasing power of your savings; on that basis cash isn't risk-free as inflation would erode its value.

"The only risk-free asset class is inflation-linked bonds as they will guarantee an increase in the purchasing power of your savings over time."

Niko Kloeten can be contacted at niko@goodreturns.co.nz

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