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Analysis: One of the biggest threats to the fixed income component of one’s portfolio is the impact of inflation can have on its value. One product type which can help to address this erosion of value is a real return bond fund. Real return bond funds invest in real return bonds, which are bonds that adjust both the coupon payment and the principal value based on the level of inflation in the economy.
One of the better choices in the inflation protected fixed income category is the IA Clarington Real Return Bond Fund. The fund, managed by 25 year veteran Francois Lalonde, invests in Canadian federal and provincial real return bonds. The manager employs an active and opportunistic approach in managing the fund, which is possible given its relatively small asset base of $71 million.
As of November 30, the fund is invested 73% in Government of Canada Real Return Bonds and 24% in provincial real return bonds. The quality of the portfolio is very high, with the average rating being “AAA”. The costs for this fund are reasonable, with an MER of 1.39%, which is one of the lowest in the category.
While this may be one of the best funds in the category, one has to wonder if it makes sense at the moment to hold real return bonds in your portfolio. Real return bonds tend trade off of inflation expectations and will outperform when the actual level of inflation is higher than the expected level. Looking at the current inflation expectations, the bond market is pricing in a level of inflation of approximately 2.1%. While recent inflation numbers have been closer to 3%, the longer term trend is for lowered inflation and the Bank of Canada is targeting inflation of between 1% and 3%. Given that, we would be reluctant to have much real return bond exposure in our portfolios and would likely lean towards a fund where the manager has the ability to add some real return bond exposure to the fund when they feel the opportunities exist. That said, for those who absolutely want some direct exposure to real return bonds in their portfolios, this would be our top mutual fund pick, given its lower MER, smaller asset base and opportunistic management style.