Norges, the world’s largest sovereign wealth fund, is fleeing out of inflation-linked bonds in a sign of how many large investors are souring on the asset class

May 8, 2013 4:44 pm

Norway’s oil fund dumps inflation-linked bonds

By Richard Milne in Oslo and Robin Wigglesworth in London

The world’s largest sovereign wealth fund is fleeing out of inflation-linked bonds in a sign of how many large investors are souring on the asset class. Norway’s oil fund has cut its holdings of inflation-linked bonds by 73 per cent in the past year and almost halved them in the first three months of this year alone. Yngve Slyngstad, head of the oil fund, told the Financial Times that, in theory, inflation-linked debt was one of the ways investors could hedge the risk of negative real yields in government bond portfolios. But he added that the oil fund was in fact reducing its exposure to inflation-linked bonds sharply because it had concluded that it was not a big enough market.The actions of the $750bn oil fund are closely studied by other investors as it is one of the biggest participants in global markets, holding on average about 1.25 per cent of every listed company in the world.

But the fund has lost enthusiasm for the bond marketsdespite about $275bn in holdings as executives at Norges Bank Investment Management, which manages the oil fund, fret about the low returns from government debt – in particular in the coming years.

It allocated a record low percentage of its assets to bonds in the first quarter and a small but rapidly increasing amount to real assets in the form of property.

The fund had about NKr95.7bn in inflation-linked bonds at the end of June last year and reduced that to NKr42.2bn by the end of 2012.

It finished the first quarter with just NKr26.1bn in linkers.

Its concern comes as other investors turn bearish on inflation-linked debt.

Aside from the UK – where the benchmark gauge overstates the mainstream inflation rate that most other countries track – investors’ inflation expectations have been falling across most developed and emerging markets due to renewed concerns over deflation risks.

In the US, the so-called “break-even rate”, which measures the difference between conventional and inflation-protected bonds, indicates that investors expect inflation of 1.94 per cent annually over the next five years, down from a peak of 2.4 per cent in mid-March.

Concerns over inflation are even more muted in Europe. The five-year break-even rate in Germany is 1.27 per cent and in Italy 1.1 per cent compared with the European Central Bank’s target of keeping inflation below but close to 2 per cent.

“Deflation has come back on the table,” said Mark Alexandridis, a fund manager that specialises in inflation-linked bonds at First Principles Capital Management. “We’ve moved all of our developed market exposure into the short end of the curve, given that we think inflation expectations are well anchored.”

Even in emerging markets, where inflation has been a perennial problem, expectations of the pace of future price increases are abating.

In Mexico, the five-year break-even rate has fallen to 3.36 per cent, down from over 4 per cent last autumn.