Further Australian inflation-linked bond issues are likely as a result of the growing recognition of inflation protection from local and offshore investors, an investment manager has said.
"Inflation-linked bonds are an ideal defensive asset class in that they provide a nice diversifier to high-risk strategies, such as portfolios heavily invested in equities," Ardea Investment Management principal Tamar Hamlyn told InvestorDaily.
"Whether they are personal, corporate or super fund investors, they're finding a need for inflation protection [as] there's nothing worse than getting great absolute returns, then finding out inflation has taken away most of it."
The physical inflation-linked bond market, comprising Commonwealth and semi-government bonds, now stood at more than $32 billion.
Further issuance for the sector was expected to continue.
Investors could be more prudent with their portfolios as local and global risks were pointing towards higher inflation in the future, Hamlyn said.
"Wages are rising 3 to 4 per cent every year, but productivity is rising only by a half per cent per year, so the difference has to be made up by inflation," he said.
"That hasn't happened yet, but that's a concern of the Reserve Bank of Australia about what could happen in the future."
While most investors understood the effects of inflation, it was still challenging to relate it back to investments, he said.
Inflation-linked bonds offered a real return of 2 per cent to 3 per cent, while conventional government bonds gave a nominal return of between 3 per cent and 4 per cent, which included inflation.
"Investors need to do their homework because what tends to happen is that they'll go for the highest number without taking inflation into account," he said.
The "internationalisation" of the Australian bond market was in its beginning stage, as interest from offshore investors in domestic inflation-linked bonds was also climbing, he said.
"It's very easy for global investors to overlook us and effectively not play any role in Australian bond markets, whereas that's now starting to change [due to] the deterioration of the credit quality of larger debt markets," he said.
"Australia is rated AAA, we've got a healthy economy and our currency is quite strong, so there's now large international investors actually investing directly in Australian bonds and that creates a lot of market opportunities."
