Inflation-Linked Bond Indexes

January 24, 2006

iBoxx launches a new suite of indexes designed to tracked the growing market for inflation-protected bonds.

The International Index Company (IIC) launched a new suite of indexes on January 24 that slice and dice the rapidly growing global inflation-linked bond market into every category an investor could want: country, region, currency, maturity band, etc.

Interest in inflation-linked bonds has risen rapidly over the past few years (no pun intended), with energy prices up sharply and inflation running a little hot in many parts of the world.  The global market for inflation-linked bonds has grown from less than $100 million to over $700 million in the past decade. 

As the name suggests, inflation-linked bonds provide investors with protection from the inflation bogeyman, and are one of the safest investments on earth. The bonds come with two return components: One that tracks the prevailing rate of inflation, and a second that provides a fixed return on principal. That fixed-return is lower than the return on a comparable "normal" bond, which is the price you pay for the inflation protection; the difference is called the "breakeven inflation point," and generally averages about 2.5 percent.

"Following customer demand, we are very pleased to introduce our iBoxx Global Inflation-Linked Index Family, which complements our existing investment grade bond indices and provides a coherently designed suite of indices with global coverage," said David Mark, chief executive of IIC. "The inflation-linked bond market is growing steadily, both in traded volumes and importance for investors, and the new indices address their needs."

The new iBoxx Inflation-Linked Index Family covers:

·        An overall global index,

·        Regional indexes for North America, Asia and Europe,

·        Currency indexes for CAD, EUR, GBP, JPY, SEK and USD,

·        Country indexes for Canada, France, Greece, Italy, Japan, Sweden, UK, and USA

·        1-5, 5-10 and 10+ years maturity band indexes, and

·        Base inflation indexes 

The bonds that make up each index are chosen by a suite of leading investment banks, which is standard practice in the bond indexing industry. 

The most established player in the inflation-linked bond indexing market is Barclays Global Investors, which offers a limited (but well-received) family of inflation-linked indexes.  The iBoxx indexes cover more specific slices of the market.

A Brief History of Inflation-Linked Bonds

According to PIMCO:

 "The concept of inflation-linked bonds can be traced back to 1780, when the Massachusetts Bay Company sold a precursor bond that was tied to the price of beef, shoe leather and other staples. The strategy didn't catch on, however, and lay dormant until 1950 when Iceland sold inflation-linked bonds to address 15% inflation-a concern that quickly dissipated when inflation dropped to zero the following year. In 1981, the modern inflation-linked bond market began when the United Kingdom leveraged the strategy with a ₤1 billion sale. Shortly thereafter, the trend caught on and Sweden, Canada and Australia also issued inflation-linked bonds. In 1997, the U.S. entered the market with its first auction of Treasury Inflation Indexed Securities, often referred to as "TIPS."   

The practice has now spread throughout the world, and most recently to Japan, which launched its own inflation-linked bonds in 2004.  That, of course, is a telling development, as Japan is only just starting to dig itself out of a deflationary spiral, which had seen prevailing interest rates on most loans drop to zero.

TIPS, by the way, now represent about 5 percent of all outstanding U.S. Treasuries.  

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