Andy Weir, manager of the Fidelity Funds Global Inflation-linked Bond fund, talks to Neal Underwood.
Q: You launched the Fidelity Funds Global Inflation-Linked Bond fund in May 2008. What was the rationale for launching the fund?
A: We launched the fund following several conversations with clients. It came from the fund of funds guys; they were looking for some inflation protection. Some people were also coming to us trying to match their liabilities.
Q: Why have you decided to adopt a global rather than just a UK approach to inflation-linked bonds?
A: The index-linked market is highly idiosyncratic. Whenever inflation rises high in Britain it’s been a global phenomenon.
To get that hedge we operate globally, which also means we get more liquidity. The UK market is incredibly dynamic, and you can’t ignore it, but we also look further afield.
Q: What advantages does a global universe bring?
A: Investing globally also increases the number of sources of potential alpha for the fund. These include duration, market selection, the break-even trade (whether to use nominal or inflation-protected bonds), the curve trade and credit. It’s a fund that’s meant to give inflation protection.
We have different decisions, to diversify its risk between different trades. We have set relatively modest alpha targets and we are trying to get it from multiple sources. The risk is also lower in aggregate than a single currency because of this diversification.
Q: What is the difference between inflation-linked bonds and other government or corporate bonds?
A: Inflation-linked bonds, just like other bonds, pay a regular coupon and return the original capital on maturity. The major difference is that a ’linker’s’ coupon and capital grow in line with inflation, ensuring that the investor’s money preserves its spending power over time.
Q: How big is the inflation-linked bond market?
A: Global issuance of inflation-linked bonds has doubled to $1.4 trillion [£750 billion] since 2005. The major issuers include the governments of America, Britain, most of the eurozone governments, Japan, Canada and Australia.
At present US bonds, Treasury Inflation Protected Securities [Tips], account for about one third of the market, with the UK and Europe around a quarter each.
Q: Is most of the portfolio in government issued bonds?
A: Our investment universe is the entire global inflation-linked bonds market, the majority of which are government issued.
There is a small weighting in nominal corporate inflation-linked bonds, but corporates generally tend to be illiquid – usually large pension funds just hold them for a long time.
We operate in the major government inflation-linked market, so all are investment grade and all are Organisation for Economic Co-operation and Development [OECD] members.
Q: Where are the real opportunities at the moment?
A: We are trying to add value in different markets, such as Japan, which is coming out of a decade of deflation. There is not a lot of inflation priced in, so we are taking a keen interest. Another market of particular interest is Mexico, where the deflationary pressures that have occurred elsewhere do not appear to be in evidence.
Other opportunities include Brazil which is very close to being investment grade. Historically investors have not been interested in Brazil without getting inflation protection.
Asian markets are more difficult to access. It’s hard to get access to Asian inflation as few if any Asian governments issue inflation-linked bonds.
Q: Can you describe your process?
A: The fund uses a multi-strategy approach to managing its assets, with a range of inputs such as analysis of interest rate movements and credit research.
Before managing the fund, I was head of Fidelity’s quant team; hence I am very interested in quantitative modelling. We rely heavily on the quant team for inflation forecasts, for example.
Q: How much of an advantage is it being part of an organisation like Fidelity?
A: Fidelity’s depth of resources is essential in running this type of product. You need a team of credit analysts, and you need a team of traders in Asia, America and the other markets. You need to pull on the full global research resources. My job is then to filter that information.
Q: Should investors be worried about inflation?
A: Investors who fail to shield their savings from the rising price of goods and services could see the real value of their money halve in just 20 years.
In the year to the end of May 2008, global inflation sat at 3.9%, according to the OECD, which covers nearly 30 countries, but excludes many of the emerging market nations such as China and India where prices are rising far faster.
Over this period, consumer prices in the US rose 4.2%, while in Spain the Consumer Price Index [CPI] rose 4.6% and in Belgium 5.2%. UK inflation has now risen to a relatively high 3.3% and the old measure of the Retail Price Index [RPI] has reached 4.3% over this time.
Q: What is driving up inflation?
A: Energy was the major contributor to price rises, running at a global rate of 14.6%, spurred by an escalating oil price. Food prices have also been rising faster, up 6.1% internationally.
If one strips out energy and food, then inflation is running at a more moderate 2.1%. Inflation is rising all around the world. Food, energy and commodity prices are all being pushed upwards by increased demand, particularly in the emerging markets where the economies remain in robust health, against a backdrop of tight supply.
Q: Do you need a high inflation environment for this fund to be popular with investors?
A: Even in times of low inflation, it makes sense to inflation-protect at least a portion of one’s portfolio. Bond markets are not fully pricing in the risks of inflation, so investors who want the prospect of a real rate of return need to look for specific protection.
This fund should suit anyone who is performing asset allocation. It aims to beat the international benchmark of inflation-linked bonds by an annualised rate of 0.75% over the longer-term. It should be a core holding in a portfolio.
We are seeing interest from Asia because they can’t hedge their own inflation. It gives you inflation protection and gets you away from the idiosyncrasies of the UK market. You are getting higher yield and higher alpha.
Andy Weir is the manager of the Fidelity Funds Global Inflation-Linked Bond fund. He joined Fidelity in 1997, initially as a quantitative analyst, then as director of quantitative research. He started managing portfolios in 2003 and in 2006 became group leader, bonds.