Inflation rises. Inflation-linked bonds should keep up. It sounds straightforward, but what happens when those bonds sit inside a fund?
The inflation link is a feature of the underlying bonds’ payments. A fund’s value also reflects changing market prices, which can fall even while those payments are being adjusted for inflation.
Our latest adviser research, Inflation-linked gilt funds: Understanding their role in a defensive portfolio, examines that distinction. It explores how maturity, sensitivity to changing yields and the wider portfolio affect the role these funds can play.
For financial advisers only. This research is intended for financial advisers and must not be distributed to retail clients.
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UK index-linked gilts, often called linkers, adjust their interest payments and repayment amounts in line with the Retail Prices Index, or RPI.
But the return an investor receives also depends on the price paid. An individual linker bought at a negative real yield can deliver less than its inflation index over its remaining life, even if held to maturity, before costs and taxes.
A fund adds another distinction: it holds a changing portfolio of bonds rather than a single bond with one repayment date. Movements in those bonds’ market prices affect the value of the holding.
Inflation-linked payments do not guarantee that a fund’s total return will keep pace with inflation.
Duration measures a bond’s sensitivity to changes in yields. For linkers, changes in real yields, meaning yields relative to the relevant inflation index, are particularly important.
When real yields rise, existing linker prices fall. Longer-dated bonds are generally more sensitive, so the effect can outweigh the benefit of their inflation adjustments.
Shorter maturities generally reduce that sensitivity, although they retain market risk and may benefit less when real yields fall. The inflation link alone therefore tells us relatively little about how stable a fund’s price might be.
The paper compares four maturity ranges of UK inflation-linked gilt funds with conventional gilts, sterling investment-grade credit and global bond exposures. It examines returns, purchasing power, volatility, losses, recovery times and correlations.
Alongside each series’ available history, the research uses a common comparison period from December 2017 to September 2026. This helps distinguish differences between the investments from differences in their start dates1.
A separate longer-history analysis considers nine periods of accelerating UK inflation, exploring when linker returns did, and did not, keep pace with rising prices2.
Past performance is not a reliable indicator of future results. Inflation-linked gilt funds can lose value and may not keep pace with inflation. Investments and their income can fall as well as rise, and investors may receive back less than they invested.
At Timeline, bonds primarily support the growth assets within a multi-asset portfolio, particularly when equities are under stress. That makes the interaction between holdings central to the assessment.
The paper considers whether different linker maturities provide useful diversification alongside conventional gilts and other bonds. It also distinguishes that portfolio role from the use of longer-dated linkers to help meet specific future inflation-linked liabilities.
The starting point is the job the allocation needs to do. Understanding its maturity, real-yield sensitivity and relationship with other holdings provides a fuller basis for that decision than the inflation-linked label alone.
Research for financial advisers
Explore the maturity comparisons, inflation analysis and implications for a defensive allocation in Inflation-linked gilt funds: Understanding their role in a defensive portfolio.
Important information
This blog is prepared exclusively for use by financial advisers and must not be distributed to retail clients. It does not constitute advice, an offer or a solicitation to invest.
Compiled from sources believed to be reliable. Any views, opinions or estimates expressed, including any forecasts or forward-looking statements, constitute the author’s judgement at the time of writing, are not guaranteed and are subject to change without notice. None of Timeline, its directors, officers or employees accepts liability for any loss arising from the use hereof or reliance hereon or for any act or omission by any such person, or makes any representations as to its accuracy and completeness.
Past performance is not a reliable indicator of future results. Index returns exclude investment costs, and indices cannot be invested in directly. Fund returns reflect the charges of the proxies used; other funds may have different costs and results. Diversification does not guarantee against loss. Investments and their income can fall as well as rise, and investors may receive back less than they invested.