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Grocery store owner Gilles Robin works on his fruits vegetable display on Nov. 28 2006 in the Breakeyville, Que. (JACQUES BOISSINOT/JACQUES BOISSINOT/THE CANADIAN PRESS)
Grocery store owner Gilles Robin works on his fruits vegetable display on Nov. 28 2006 in the Breakeyville, Que. (JACQUES BOISSINOT/JACQUES BOISSINOT/THE CANADIAN PRESS)

Stock Trends

Real-return bond fund offers a way to bet on rising inflation Add to ...

The Stock: iShares DEX Real Return Bond Index Fund

The Trend

Inflation expectations are eating away at bond prices and forcing investors to look for ways to protect income flows in a bearish credit market environment. Worries about inflation - which clocked in at an annual rate of 3.3 per cent in March - and rising interest rates tend to drive bond prices down as investors demand bigger discounts to secure a better yield on their investments.

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There are investment instruments designed to protect income flows from inflation and interest rate changes, including floating rate bonds represented in the Horizons AlphaPro Floating Rate Bond Fund . Another inflation-protected security is the Real Return Bond, which adjusts interest payments to the realized rate of inflation and guarantees the real value of coupon payments and principal based on periodic adjustments to the reported CPI inflation rate. Issued by the Government of Canada, RRBs are similar to Treasury Inflation Protected Securities (known as TIPS) issued by the U.S. Treasury.

The Trade

The iShares DEX Real Return Bond Index Fund is a basket of real-return bonds and offers an attractive way for investors to gain diversified exposure to these protected returns. This bond ETF has been in a Stock Trends Bullish category since May of 2009 and is currently outperforming the S&P/TSX composite. The fund is trading at a 52-week high and is positioned to carry its relative price performance forward.

The average 2.5-per-cent difference in yields between nominal and real-return bonds recorded to date this year - now elevated to 2.7 per cent - is more in line with the average 2011 inflation rate predicted by surveyed economists than March's 3.3-per-cent headline inflation. However, a recent survey of Canadian corporate leaders points to business inflation expectations closer to 3 per cent and higher. Given the rising trend in expectations showing in RRB prices, this could be another sweet spot for this bullish-trending fund.

The Upside

In periods of rising inflation, RRBs will provide the purchasing power protection they are designed for, and this fund should continue to "market-outperform" and make new highs through the summer.

The Downside

Inflation-protected bonds lose their advantage over conventional bonds when inflation moves below expectations, although this remains a bearish environment for nominal bonds.

Skot Kortje has been analyzing stock market trends for 15-years using trend analysis. His Stock Trends indicators have been published by The Globe and Mail since 1995. For more go to Stocktrends.ca

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