NEW YORK -- Plan sponsors are starting to take inflation-indexed bonds seriously, said Christopher K. Kinney, manager at Brown Brothers Harriman & Co.
Brown Brothers, in conjunction with BARRA RogersCasey, Berkeley, Calif., completed research detailing asset mixes of individual defined contribution plan participants with the incorporation of Treasury inflation-indexed securities. It is the first study of its kind, according the firm.
Inflation-indexed bonds are a good inflation hedge with a low correlation to other asset classes and are viable investments for defined benefit plans, defined contribution plans and foundations. "It's a no-brainer," Mr. Kinney added.
He suggests an allocation of 10% of total assets for pension funds and the full 25% of the assets in defined contribution plans estimated to be in guaranteed investment contracts, stable value funds and money markets.
Inflation itself has had a correlation of -0.28 with stocks, 0.05 to intermediate Treasury bonds and 0.69 with T-bills in the past 50 years. The study also says nominal return vs. real return for intermediate government bonds for the past 50 years, on an annualized basis, was 6.04% vs. 2.02%, thanks to inflation.
There always will be the need for conventional bonds in a portfolio to offset the risk of deflation, said Mr. Kinney. "But if one were ambivalent whether inflation will go up or down, then a strong argument will be made to allow inflation-indexed securities to supplant the conventional bond."
Brown Brothers Harriman manages a small amount of inflation-indexed securities in its separate accounts when it is feasible, in addition to its mutual fund, 59 Wall Street Inflation Index Securities Fund, which has $13 million.
Other companies that have inflation-indexed Treasury mutual funds are Pacific Investment Management Co., Newport Beach, Calif.; American Century, Kansas City, Mo.; and Teachers Insurance Annuity Association-College Retirement Equities Fund, New York.
According to the research, individual investors can handle inflation rates of 10% before the real return becomes negative in a tax-deferred portfolio.
The authors analyzed differing allocations to the Treasury inflation-indexed securities by the age of the investor when he or she starts saving and expected retirement age. The result: The earlier the saving begins, the earlier the inflation-indexed Treasury allocation should begin to ensure an early retirement.
The model in the research used the returns of the Standard & Poor's 500 stock index and 30-day Treasuries from 1953 to the present.
An asset allocation of 80% stocks and 20% inflation-indexed Treasuries, until age 60 or so, is the mix suggested by the Brown Brothers and BARRA research. At retirement at age 65, the mix is 40% stocks and 60% inflation-indexed Treasuries.
William Lloyd and Henry Willmore at Barclays Capital, New York, see the 30-year inflation-linked bonds as "an attractive investment opportunity." Mr. Willmore, a senior economist at the investment banking firm, and Mr. Lloyd, head of marketing strategy, are predicting the core inflation rate will increase to 2.8% from 2.5% in the second half of the year and to more than 3% in 1999.
Barclays currently trades about 18% of the total inflation indexed market.
Consultants have yet to embrace the concept.
Warren Mulhern, director of operations for Advest Custom Consulting, Hartford, Conn., said his firm concluded the bonds were a great idea, but with the current environment of nonexistent inflation, it's hard to convince clients to add them as an asset class.
"In the late '70s when we had double-digit inflation, it would have been like a cure for cancer," Mr. Mulhern said.
But Jeffrey Ross, a consultant with Arnerich & Massena, Seattle, said he doesn't see any advantages.
Clients of Buck Consultants have not shown interest in using the bonds either, said Jonathon Mueho, investment consultant.