An index-linked bond is a fixed-income security whose return is referenced to the evolution of a macroeconomic magnitude that acts as an index.
Therefore, we are dealing with a financial product that has the peculiarity of being indexed, that is, it depends on a variable such as inflation or GDP, among others. In this way, if it varies, the performance also does.
These bonds have been used in developing countries to raise financing, although in times of crisis they are also common in developed countries. For example, a recession affects inflation and by being referenced to it, it becomes attractive for the investor.
Types of indexed bond
Basically, we have five types of indexed bond according to the index that we use as a reference to calculate its profitability:
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- Inflation-linked bond: We will see this in more detail below, but its main characteristic is that its profitability depends on increases in the CPI, inflation.
- Bond linked to commodities: Its performance is related to the evolution of the prices of commodities, that is, basic products such as rice, oil or copper.
- Bullish or bearish bonus: In this case it will depend on the stock market and its evolution.
- Currency-linked bonus: As its name suggests, it is the currencies that determine the evolution of its profitability.
Inflation as an index
This is the most common indicator in the index bond. Normally, as we have already mentioned, these bonds are used to finance the public administration in times of crisis and in these cases, inflation is usually affected.
Therefore, what the State does is attract investors by promising returns linked to that inflation. This is how they get them interested in this type of bonds in which they would not invest in a normal situation.
Of course, not everything is attractive for the investor, there is also a risk. First of all, we must take into account the inverse relationship between market price and profitability. If the performance increases, the price decreases.
On the other hand, if deflation occurs when we are going to sell it, its nominal value could be reduced, although there is usually a floor that acts as a mitigating factor. In this way, if inflation is greatly reduced, this floor serves as a stop.
We cannot forget a key concept, the “inflation deadlock”. This would be the difference between nominal and real profitability. Therefore, we are really facing an inflation expectation that, in turn, the market discounts.
If the real inflation rate, throughout the life of the bond, is greater than that breakeven point, the yield of the indexed bond will be higher and the risk will be lower. Of course, the opposite situation can occur.
Some indexed bonds
Financial entities market this type of bonds through investment funds. Let’s see some of the most relevant:
Caixabank Smart Fixed Income Inflation: It is a fund with bonds indexed to inflation and in the first weeks of 2022 it accumulated a rise of 1.12% or 4.78% annualized over three years. His portfolio includes sovereign debt from Italy, France and Germany. It is marketed by Caixabank.
Nordea1 European Inflaction Linked Bond Fund: Two-thirds of its assets are bonds of this type, with inflation as an index and complemented by high-quality titles. In addition, it uses sustainable investment criteria. In 2021 its yield was 5.4%. It is marketed by Norde AM.
Ostrum Euro Inflation: Up to 75% of the portfolio is made up of the inflation-indexed bond. Also, their commissions are very low. In 2021 it achieved almost 6% profitability, this being one of the highest in the market.