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PIMCO Rolls Out Global TIPS ETF

tlydon@globaltrend.com (Tom Lydon)

PIMCO Global Advantage Inflation-Linked Bond Strategy Fund (ILB - News) began trading on Tuesday. The ETF will seek to provide above-inflation returns by actively managing global inflation-linked bonds and currencies.

ILB is the latest actively managed ETF from bond giant PIMCO. Two months ago, the firm launched PIMCO Total Return ETF (BOND - News). [ETF Chart of the Day: BOND]

I recently spoke with Mihir Worah, Managing Director and Head of PIMCO’s Real Return portfolio management team, who heads up the inflation hedging business side at PIMCO. He will oversee the fund’s daily operations and guide the overall portfolio toward countries experiencing stronger growth, instead of relying on a market-cap weighted index, which may heavily favor the most indebted issuer, or in the case of inflation-linked bonds, country specific inflation-linked bond issuance.

Inflation-indexed bonds, real return securities or inflation-linked bonds are bond securities with their principal indexed to the current inflation level. Consequently, these securities are intended to take out inflation risk and provide long-term returns above the current rate of inflation.

The new active fund will maintain about two-thirds of its inflation-linked bond holdings from developed countries and one-third of its holdings from the emerging markets. It should be noted that the fund will be exposed to foreign currency risks to maintain its high yield exposure.

Developed country bonds currently sit in low inflation but also provide limited yields. The U.S. inflation rate was 2.7% in March but yield on bonds are close to zero percent. In contrast, the quick growth in the emerging markets has spurred inflationary pressures to about 3% to 5%; however, rates of return remain much more attractive. For instance, Worah pointed out that Brazilian inflation-linked bonds show yields of 5% on top of inflation and Mexico’s inflation-linked bonds have yields of 3% on top of inflation.

Considering the current inflation levels, Worah believes that the fund will provide investors with a moderately priced entry point into this market.

“Over the last 20 years, U.S. has experienced a two to two-and-half percent inflation rate,” Worah said. “We see three to three-and-half percent somewhat higher later. For the emerging markets, we also expect inflation to somewhat increase, as well.”

Investors, though, need to be aware that the fund is still based on government bonds and interest rate risks still apply. However, central bankers may not hike rates any time soon. The U.S. is still holding out until 2014, Brazil recently cut rates by 75 basis points and India reduced rates by 50 basis points.

“Don’t expect central banks to raise rates across the globe over the next year or two,” Worah added.

To get an idea of what the overall ILB fund will yield, take a look at U.S. Treasury Inflation-Protected Securities ETFs; TIPS are generating inflation minus 9 basis points, or inflation plus zero, pointed out. ILB, though, would have a target yield of around inflation plus 1.5%.

The ILB ETF comes at an opportune time when advisors are increasingly looking for fixed-income assets. With Treasury yields at their historic lows, advisors have been expanding their fixed-income horizons, targeting overseas markets. Specifically, in the emerging markets space, higher growth prospects coupled with stable balance sheets have attracted more advisor interest.

“In this uncertain global economy, some of the key drivers of growth are developing economies, which are often more sensitive to inflationary pressures like commodity prices,” Worah said in the press release. “Our forward-looking Global Advantage approach aims to expose investors to the inflation-linked bonds and currencies of these faster-growing economies, potentially resulting in higher real yields than traditional investing using market cap-weighting.”

The ETF will be PIMCO’s latest addition to its active bond fund suite.

“We are serious about the active ETF space,” PIMCO’s Bill Gross told me leading up to the ETF Virtual Summit.