NEWPORT BEACH, Calif., Aug. 18, 2001 (PRIMEZONE) -- PIMCO, home to the nation's largest inflation-indexed bond mutual fund, believes that such bonds provide important benefits to both savers and the United States government -- and believes the U.S. Treasury should not stop issuing Treasury Inflation Indexed Securities ("TIPS").
"To paraphrase Mark Twain, we believe that rumors regarding the demise of TIPS have been greatly exaggerated," said John Brynjolfsson, PIMCO Executive Vice President and Portfolio Manager of the PIMCO Real Return Bond Fund, the nation's largest fund devoted to such bonds. Brynjolfsson continued, "In fact, we have found that equity market volatility has highlighted the needs that our Real Return Products address and more investors than ever are asking for TIPS. As a result, we recently filed with the SEC to expand our menu of offerings and are currently awaiting a response."
Inflation-indexed bonds, popularly known as TIPS, are designed to guarantee a specified growth of purchasing power over long periods of time, regardless of changes in the Consumer Price Index. The bonds, first offered in 1997, now total about $140 billion in market value, and about $2 billion worth change hands in the secondary market on an average business day. Previously issued TIPS, which are all non-callable, would continue to trade in the secondary market for the next 28 years regardless of any change in policy. PIMCO alone manages in excess of $13 billion, with over $3 billion of that in portfolios primarily dedicated to TIPS.
The size of PIMCO's publicly available Real Return fund is powerful testimony to the popularity of such bonds with investors; as of August 15, that fund alone had more than $1.5 billion in assets under management, an increase of more than 131 percent since the beginning of 2001.
Despite TIPS popularity -- and in one sense, because of that popularity among investors -- there has been speculation in the financial media that the program may be abandoned, or at least substantially downsized by the Treasury, which may fear it is giving away too much. Critics of the Treasury's issuance program have suggested that over the past four-years TIPS have cost the Treasury more than conventional bonds. Ironically, some of these same critics simultaneously question whether, in the current economic climate, inflation is enough of a threat to justify TIPS' purchase by investors.
TIPS have performed exceptionally well in recent months; 10-year TIPS currently yield 3.34 percent on top of inflation, substantially more than the inflation-adjusted yield of on 10-year conventional Treasury bonds of 1.92 percent. That's great news for investors, but appears to be relatively expensive for the Treasury.
Long-term, however, PIMCO believes the yield gap between TIPS and conventional bonds is likely to shrink. As more investors become aware of TIPS' advantages -- their value as an inflation hedge and their negative correlation with equity returns -- demand for such bonds will increase, the investor base will broaden, and the gap will naturally narrow.
"Fiduciaries and investment boards, appropriately, are very contemplative before they make large scale forays into new asset classes. It is unreasonable to expect the TIPS market to fully mature in four short years!" Brynjolfsson retorted.
Brynjolfsson also noted that TIPS, which grow more expensive to the issuer when inflation increases, naturally provide the government with a strong incentive to control inflation. And the existence of that incentive has already been reassuring to fixed income markets, as is evidenced by the drop in yields on conventional government debt. While U.S. inflation is about the same as when TIPS were introduced in early 1997, 10-year nominal Treasury yields have fallen by some 175 basis points. Indeed, development of the TIPS market corresponded with a strong rally in the U.S. Treasury market. There are numerous other reasons for that phenomenon -- including the growth of the federal surplus -- but PIMCO does believe that the existence of TIPS has been an important contributing factor in the rally.
Brynjolfsson also expects TIPS to continue providing important benefits for their buyers, even at a time when inflation concerns are waning.
In the first place, he noted, "Market expectations for declining inflation may be overly optimistic." Based on the breakeven inflation rate, which is calculated by taking the difference between similar maturity conventional Treasury and TIPS yields, investors are accepting an inflation premium in conventional Treasury bonds of only 1.72 percent (5.06 percent less 3.34 percent) over the next decade.
"Our forecast calls for inflation to ease lower to about two percent over the next several quarters. As long as the actual inflation rate remains comfortably above the breakeven inflation rate, TIPS should outperform Treasuries."
Finally, Brynjolfsson stressed that PIMCO has received no indication that the Treasury intends to eliminate or even reduce the sale of TIPS.
"In fact," Brynjolfsson said, "the Treasury has publicly announced that it has no plans to cut its annual issuance of 10 and 30-year TIPS. Even before the recent tax cut, spending increases, and a softer economy ate into the surplus, the Bush Administration's Office of Management and Budget published estimates that total outstanding TIPS would be nearly 15 percent of publicly-held Treasury debt, versus less than five percent at present."
Disclosures and Data
With more than $220 billion in fixed income assets under management, PIMCO is one of the world's leading fixed income fund management companies. Founded in 1971 and based in Newport Beach, Calif., the company is majority owned by Munich-based Allianz Group, a leading global insurance company with nearly $670 billion in assets and represented in 70 countries around the globe. In addition, PIMCO manages a family of 64 stock and bond mutual funds available to both retail and institutional investors.
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