Paul: Welcome to Index Ideas from FTSE Russell. I'm Paul Amery, your podcast host. In this podcast we look into how FTSE Russell indices are built and why. We explore index ideas that can help you address real-world investment challenges. As a reminder, you can't invest in an index. And so the concepts that we discuss in the podcast are not investment advice. Any reference to potential investment strategies is intended for informational and educational purposes only. In this episode of the podcast, we look at a segment of the fixed income market that's recently been attracting a lot of interest, inflation-linked bonds. I'm joined by Jack Fischer, who is US fixed income, currency and commodity product lead at FTSE Russell. Jack, welcome back to Index Ideas.
Jack: Paul, thank you for having me.
Paul: Jack why are inflation-linked bonds, or inflation-linked securities as some people call them, ILS, seeing a resurgence in interest?
Jack: Well, last time you had me, we talked about this a bit, but there's been this renewed focus on non-dollar denominated exposure. I think investors looked at their current portfolio, looked at the current landscape, and they realised that their investments were overly exposed to the US dollar. So there's been this kind of renewed interest in international debt, international exposure, not only on the fixed income side, but on the equity side as well. And one of these areas that has been overlooked in recent periods is international inflation-linked securities. So international inflation-linked securities ex-US outside the US, outside of US TIPS (Treasury Inflation-Protected Securities). And that's been overlooked for a couple of reasons: the strong dollar, low real yields, relative stability in the global markets. And that's all flipped. We're in a different regime now: the real yields are at a level where it's enticing investors to subscribe. There's reasonable break-evens. And then, the geopolitical kind of landscape, is what it is, where investors are looking not only for an inflation hedge, but, that ex-US dollar exposure.
Paul: So Jack, how big is the inflation-linked market and how does this compare to the conventional bond market?
Jack: Yeah. So FTSE Russell has two flagship indices: WILSI, which is the World Inflation-Linked Securities Index, and then EMILSI, which is an EM-focused index. You know they both follow our flagship kind of WGBI governance, so WILSI includes some EM markets in there. And then EMILSI is just kind of just EM on its own. But together there are about $1.3 trillion in par outstanding. And to kind of put that into context, it's larger than the EM US dollar government bond index, larger than the world high yield market ex-USD index. So you know, larger than some of those other ex-US international indices that are tracked by FTSE Russell. But the larger portion of the sovereign space is in nominals and that's about $37 trillion.
Paul: Okay. And within the inflation-linked sector how do you categorise it by type of issuer, whether that's sovereign versus corporate or, you mentioned, developed versus emerging. Are there any figures there that you'd like to share?
Jack: Yeah. So the WILSI and EMILSI, they only track sovereign inflation-linked securities. So WILSI is 13 countries and EMILSI is seven countries. And then there's actually a third, which is the FTSE International Inflation-Linked Securities Select Index, which is an index tracked by an ETF, State Street ETF WIP and that then merges the two to make a more investable, trackable index. And that covers 19 [countries’] securities ex-US.
Paul: And how much investor demand for index-linked, inflation-linked securities has there recently been, based upon the fund data that you analyse?
Jack: Yeah. So in the US ETF market there's about 50 ETFs that are in this inflation protection category. But there's only one that focuses on international ex-US. And that's that WIP ETF. But within inflation-linked securities, within the US TIPS market, that took in about $18 billion in inflows last year, about $3 billion year to date. It's been a growing segment. And a lot of that is just due to uncertainty in the market, but also where kind of real yields are at as well. But then you pair that with this kind of international demand which is still very much a prevalent trade in the market. International income ETFs have been $8.2 billion year to date, EM local currency, about $1 billion year to date. So, you know, these are both kind of two trades happening at the same time.
Paul: Okay, great. So obviously, you can't give investment advice to listeners, but from an index construction perspective, what are the pros and cons of the indices you mentioned earlier? WILSI ex-US and SILSI for, let's say, a US investor who's looking to diversify into global inflation-linked bonds.
Jack: Yes. I mean, so certainly I'm not a market forecaster by any means. Interesting, as I was writing this paper, I started researching in November. And since then international inflation-linked securities, SILSI, which is this ex-US select index, WILSI and EMILSI have been the top-performing really fixed income exposures over the trailing year and year to date. So they offer different kind of profiles. You know, WILSI is this developed market-focused inflation-linked index. And what goes along with that is a bit of longer duration. You know, these are larger developed markets that issue longer in the curve. So the nuance within WILSI versus really EMILSI is this idea of longer duration and this indexation lag. So with developed markets, there tends to be a longer indexation lag. And what that means is, you know, the inflation felt in market, in February, won't really be realised until three months, two and a half months later. And that's just how these countries record their CPIs and publish their CPIs. And then it gets reflected in coupon amounts from the underlying securities. And that varies from more of the EM kind of inflation-linked securities where these indexation lags are weeks, maybe one month. So their duration exposures are very much on the short end. And they in a way better reflect or more quickly reflect the price effects that are happening on the ground.
Paul: So, Jack, we've recently seen an inflation scare as a result of the Gulf War that broke out at the end of February. What's been the impact on the inflation-linked bond market?
Jack: Well, performance-wise, there's still a lot of uncertainty in the market. And we're still in this fog of war. And I think we're all suing for peace. But the last three months, inflation-linked securities have performed very well and more so in these emerging market countries. You know, I think there's an important point here that this exposure and this sector doesn't only perform well, it's not only driven by inflation spikes, there's also a currency movement because these things are in local currency. So a chunk of the returns is due to the strength of the dollar and the strength of these local currencies versus the dollar. At least how the US investor would perceive it. So given that aspect as well, these things have performed well recently. In terms of a broader portfolio and looking forward, how should an investor view these things? Well, they provide an inflation hedge. They also provide a hedge, increased diversification in your portfolio, a portfolio that is probably overexposed to US dollar denominated debt.
Paul: Jack, you mentioned earlier on about inflation-linked securities’ real yields and the break-even inflation rates that they incorporate. What trends have you seen there?
Jack: Yeah. So, there's higher yields across the board in really fixed income sectors, but what's being supported in the inflation-linked securities market is that higher yield, the real yield is a bigger, larger portion of that higher yield. And what that means really is just it's an attractive valuation for the sector and it's an attractive point to enter. You know, break-evens, which a lot of the market tends to use as an inflation forecast, are modest. You know, interpreting that, the market is not forecasting high inflation, but the yield supporting these underlying securities are at a very attractive point. And that really just helps kind of mould the whole picture of why inflation-linked securities.
Paul: Just clarifying, Jack, that you're not offering investment advice there, but you're saying that the real yields are attractive relative to recent history, I suppose.
Jack: Exactly, yeah. Relative to historic periods, where we've been in a period of negative real yields. So yes.
Paul: Been in a period of negative real yields for some time after the financial crisis.
Jack: That's right.
Paul: And where can listeners to the podcast go to find out more about inflation-linked securities and FTSE Russell's work in this area?
Jack: Yeah. So, the full research paper is published online. It's about inflation-linked securities, the market, the indices we track that power the market. It's on the London Stock Exchange, FTSE Russell websites. There's also a few blogs published by our global research team on the impact of, and maybe the value add, of inflation linked securities within a total portfolio.
Paul: Well, Jack, thank you very much for joining me. And that's it for this episode of FTSE Russell Index Ideas. If you've enjoyed the conversation, then please follow us and give us a rating or review on your podcast app of choice. If you'd like to get in touch with the show, you can do that via the email
[email protected]. But for now, from me, Paul Amery. Goodbye.
