A lesson in inflation-linked securities

Barclays Capital talks to institutional investors in Australia about investing in a basket of global inflation-linked bonds.
Australian pension fund managers will be given a lesson on how to diversify their portfolios and decrease volatility by investing in inflation-linked products at a conference in Sydney today.

ôThis is a market with a lot of potential that has largely been overlooked in Australia,ö says Ralph Segreti, global inflation-linked product manager at Barclays Capital, who is on a tour around Asia talking to investors. He has already taken in Singapore and Seoul.

Australia is an unusual market because of the small number of sovereign bonds in circulation. That means the Australian government isnÆt likely to issue an inflation-linked bond like those that are routinely issued in other markets like the US, the UK and Canada, and more increasingly in emerging markets like Brazil. ôOn Tuesday this week, the Turkish government issued $3 billion in inflation-linked bonds, a much larger volume than was initially expected,ö says Segreti.

Now the Korean government is lining up to do the same sometime in March.

ôThere is less than $5 billion worth of Australian government bonds currently in circulation and with the country sitting on budget surpluses there is no move to increase this level,ö says Segreti. ôThat means local superannuation funds that have direct inflation or wage inflation expectations have no way of diffusing their liabilities.ö

There is some inflation swap activity in the market but not enough to meet demand.

ôWe believe there are many more inflation-linked derivative opportunities in Australia,ö says Segreti. ôThere seems to be an ever-lasting appetite for infrastructure deals in Australia, so we are suggesting that sponsors consider an inflation-linked component when putting their project finance packages together. We are also promoting derivatives like CDOIs and CCOIs.ö

Segreti says another option to consider is creating a basket of global inflation-linked bonds and swaps that Australian institutions can invest in. ôBy putting together bonds and swaps issued by entities in the UK, Europe and Canada, in particular, you can construct a basket of securities that reasonably correlate with inflation characteristics in Australia,ö says Segreti.

He says the key message from the conference will be that inflation-linked securities make a lot of sense in a diversified pensions portfolio. ôThey work well to dampen down volatility, make the efficient frontier look a little better and help to increase returns.ö

The one-day conference is being held in Sydney and is being attended by about 100 investors.
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