Question from Douglas
Do long dated inflation linked bonds help the investor in a rising interest rate environment?
Answer from Elizabeth Moran, Director of Education and Fixed Income Research, FIIG Securities
The simple answer is yes, insofar as the Reserve Bank of Australia (RBA) uses its control of interest rates as its primary mechanism to control inflation, so interest rates should only rise if inflation is rising.
Principal and interest on inflation linked bonds are linked to inflation (as measured by the Consumer Price Index, or CPI), so the value of these assets will increase as inflation rises.
As an example, the Sydney Airport Finance capital index bond maturing in November 2020 is currently yielding a quarterly coupon of CPI plus 4.65%. If CPI averages 2.50% (which is the middle of the RBA target band) over the remaining life of the bond, this bond will yield 7.15%. However, if inflation rises at some stage over the life of the bond, and averages 3.50% over that period, that directly translates into an additional 1% annual return on the bond, increasing the yield to 8.15%.