As Denmark prepares to issue its first ever inflation-linked bond at auction on 24 May, David Dyer, Senior Fixed Income Portfolio Manager at AXA Investment Managers, discusses the size of the inflation-linked bond market and looks at why institutional investors should consider going global in their allocations…
Today, the Danish government will become the newest entrant to the global inflation-linked bond market. They propose to issue an inflation linked 2023 government bond at auction, to the value of up to 6 billion Danish crowns (or USD1.06 billion) and have already had strong indications of interest.
The Danes will join a growing number of sovereigns that issue inflation-linked as well as conventional bonds to meet their financing needs. By doing so they can diversify their investor base, taking advantage of the increased structural demand from long-term investors for inflation protection. Bloomberg lists 47 different countries with inflation-linked bond issues, and we are aware of other sovereigns considering this market.
Out of the universe of inflation-linked issuers, there are currently 18 countries with sufficient liquidity and suitable market structures for institutional investment, of which nine would be classified as emerging markets. Whilst the UK has one of the longest established markets for inflation linkers, we expect that emerging markets, where inflation is often higher, will account for a greater share of this over time.
Given the breadth of the market and its likely development, it makes sense for investors to think global and diversify their credit exposure. Why? UK pension funds often choose to allocate to UK index linked gilts because they match liabilities exactly and provide protection from UK inflation. However as markets and societies become more globally orientated, inflation has also become more of a global phenomenon, and inflation is more correlated between countries.
This means that whilst global inflation-linked bonds won’t precisely match liabilities, they can approximate them, as well as providing an element of value. The effects of easy monetary policy in the UK have made investing overseas particularly attractive, as real yields are higher everywhere outside the UK.
Currency risk needs to be considered, but investors can look to add value either on a tactical basis or by making a strategic allocation to global inflation-linked bonds.