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Investment Uncovered: Do corporate bonds need inflation proofing?

This month, inflation climbed to a five-year high of 3 per cent. Insight Inflation-linked Corporate Bond fund manager David Hooker argues corporate bonds with direct inflation protection offer better returns than inflation-linked gilts as Money Marketing crunches the numbers.

Talk us through the fund

The fund aims to give investors a return that, in the medium term, is in line with or beats UK inflation. We try to protect the fund from rising inflation by investing in assets with the investment characteristics of inflation-linked corporate bonds.

It has sensitivity in reaction to expected inflation. We use Insights’ institutional investment process and views of the world and apply those to the fund in the most appropriate way.

The fund size is increasing from the current £58m. We’ve seen net inflows into the fund this year so far, I suspect because you are seeing much more focus in the media on the current level of UK inflation.

What is your outlook on interest rates and inflation?

We currently look at the outlook in interest rates and we see a possible first move from the UK in November. This is largely because the global environment is stronger than what the Bank of England thought a few months back.

The UK exports a lot of goods and services, it is exposed to trends in the global environment and that has not been beneficial to the UK now, given the strong demand for UK exports, and that has given a tailwind to what has been a better UK performance than many people expected after the vote to leave the European Union last year.

The worst-case scenario the Bank predicted has not panned out and now they are looking to wind back some of their extra stimulus. That gives us a more cautious approach to the market not just in the UK but also globally.

Top tips on how to pick a passive fund

When I look at my fund, we are taking a much more cautious approach on the amount of interest rate risk than the fund currently holds by running less duration.

The other part of the inflation market that we really like is in the US. Inflation pricing there is very low. The Federal Reserve had an inflation target like the UK and the target in the US now is running below their preferred rate and that is reflected in the price of the 30-year US inflation bonds. On that measure, we think holding 30-year US inflation protection is a cheap asset class at the moment.

Why should advisers pick your fund?

This is a very specialist field. There are very few funds that advisers can select which give you yield premium in corporate bonds combined with inflation protection.

When we look at the average investor’s portfolio we can see that they have a lot of exposure to traditional corporate bond funds.

They do very well in an environment where inflation expectations are generally falling.

What you’ve seen in the last 10 to 20 years, is that expectations of inflation were falling largely because headline inflation has been lower as well and that is a good environment for traditional corporate bonds.

If that environment was to become less friendly in the future, where we would worry about higher inflation, then those funds will find it harder to perform going forward. So something with a direct link to inflation should outperform in that environment.

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