Inflation is on the way. Or so a group of Canada’s top hedge fund managers decided at last month’s AIMA Canada debate in Toronto.
As the winning debater Hubert Marleau, co-founder of Palos Management in Montreal, argued we’re being pushed into an inflation scenario by a high consumer price index in the U.S., increasing producer prices and worryingly high import prices—not to mention poor monetary policy.
Inflation is a major risk for DB pension plans. So if the majority of those hedge fund managers gathered in Toronto are right, plan sponsors need to take steps to deal it, which is why more plans are turning to real return bonds.
Real return bonds are, of course, adjusted for inflation—so that means they’re a match for at least one big pension liability.
Since real return bonds are pretty straightforward to get in and out of, most pension managers take a do-it-yourself approach—they construct their own portfolio and, in doing so, cut out the management fee.
Seems like a no-brainer right?
Well, it could depend on how long you want to hold your bonds—plan sponsors looking for shorter-term exposure to real return bonds (say, 20 months or less) might want to consider real return bond exchange traded funds (ETFs). Yes, you end up paying a management fee but plan sponsors can get a pretty big break when it comes to the transaction costs.
Indeed, real return bond ETFs can offer significant savings on that front that can outweigh the benefits of going it alone.
Here’s how it works. Look at the iShares Dex Real Return Bond Index Fund as an example. Although you’ll pay 35 basis points as an annual management fee, the transaction costs are only 21 basis points—that’s compared to the 50 bps you’d pay on the DIY side.
Comparing costs, the ETF approach is actually nearly 30 bps cheaper on both the buy and sell side of the transaction (that’s after all costs are taken into account).
Of course, it’s not a long-term solution. Hold the ETF for longer than 20 months and the management fees make it a costlier option.
But if you’re looking for short-term exposure to real return bonds to weather the rising tide of inflation (if that’s the side of the debate you agree with!), then ETFs might be your best bet.
