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By Christine Benz | 08-10-2010 05:06 PM

Building an Inflation-Fighter Bond Portfolio

Fixed-income investors need to look beyond TIPS when constructing an inflation resistant portfolio says Morningstar Investment Services' Marta Norton.

Christine Benz: Hi. I'm Christine Benz for Morningstar. Even though inflation is well under control currently, investors ignore it at their own peril. Marta Norton, an Investment Manager in Morningstar's Investment Services Group recently wrote an article that included a model portfolio for fixed income investors looking for inflation protection, and she is here to talk about it with us today.

Marta, thanks for joining us.

Marta Norton: Thanks for having me, Christine.

Benz: So, Marta, this portfolio includes 40% in a core global bond, 20% TIPS, 15% bank loans, 10% high-yield, 10% convertibles and 5% emerging-markets currency.

So, my question is, you usually think of TIPS as being the really obvious place to start when adding inflation protection to a fixed income portfolio, but you didn't just stop there, you think investors need to broaden their toolkit a little bit.

So, why do you think investors should look beyond just TIPS?

Norton: Sure. Well, TIPS certainly are the obvious choice when it comes to fixed income and the desire to fight inflation. But in this case, we think TIPS are somewhat of an unattractive market. Real yields are at historically low levels, and that means that investors might be getting compensated for inflation when they go to TIPS, but they're not finding much protection from, say, the threat of rising interest rates or from concerns about the economy or the federal deficit.

So we think even the investor perception of these concerns, even if that worsens, TIPS yields could spike and that would hurt bond prices there. So, when we think about inflation, we're not just thinking about TIPS as a form of protection.

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