Q&A with Robert J. Greer

Senior Vice President and Real Return Product Manager

Real return bonds, notably U.S. Treasury Inflation Protection Securities, or TIPS, offer protection against inflation because their principal and interest payments are linked to inflation. Anticipating a gradual rise in inflation, PIMCO believes that TIPS are currently an attractive fixed-income asset class. We spoke with Robert J. Greer, PIMCO's Real Return Product Manager, about portfolio applications and the outlook for TIPS.

Mr. Greer joined the firm in 2002, previously having been associated with JP Morgan Chase and Daiwa Securities as a developer and product manager of commodity indexes. Mr. Greer has over 21 years of investment experience with real return products, and has published in several investment journals and publications. He holds a bachelor's degree in math and economics from Southern Methodist University and an MBA from the Stanford University Graduate School of Business.

Q: What can TIPS add to an investment portfolio?

Greer: There are two major benefits from TIPS. One is obvious: they help us hedge against inflation. The second, less obvious but very important feature of TIPS, is that they help to provide diversification from stocks and from nominal bonds. So their applications in a portfolio are: inflation hedging and diversification.

The inflation hedging is important because investors have liabilities that grow with inflation. Therefore they have a need to preserve and enhance their purchasing power. The second benefit--diversification--means TIPS can help contribute to the balance of a portfolio, which is important.

Q: TIPS have also outperformed most nominal bonds in the past few years. In 2003, the Lehman TIPS Index returned more than 8%, while the Treasury Index returned about 2%1. Do you think TIPS could continue to perform well?

Greer: TIPS have provided terrific returns in the past as real interest rates have gone down. In the future, we expect returns to be more modest, and therefore the ability to add value through active management becomes more important. Put another way, if the asset class of TIPS is returning 10%, then an additional 1% of “alpha”--which is extra return over a benchmark--is not as important as it would be when a TIPS index is returning 4%. So alpha is important and will be more important in the future in a low return environment.

Q: How are TIPS likely to perform in an environment of rising interest rates?

Greer: That depends on what is causing the rise in interest rates. If it is rising inflation, the CPI accrual built into TIPS will capture that rising inflation rate and real interest rates might not move that much. However, if it is changes in expectations about inflation, but not yet changes in realized inflation, then real interest rates could move higher, perhaps almost as much as nominal rates of the same maturity, which would have more of an adverse effect on TIPS returns. Even in that event, the increase in real rates might be expected to be at least somewhat less than the rise in the nominal rates of a nominal bond of equivalent maturity.

Q: How does PIMCO seek to add value, or alpha, to a TIPS portfolio?

Greer: The way PIMCO actively manages a portfolio to potentially add alpha is by employing traditional curve and duration management to the portfolio, modified to accommodate the fact that TIPS are priced in terms of real interest rates rather than nominal interest rates. We can also engage in buy-forward transactions when they seem attractive. A buy-forward transaction simply means that instead of owning a TIPS, I will agree to buy a TIPS 30 days from now. The cash that I normally would have invested in a TIPS, I will invest instead in investment-grade cash equivalents in a way that the return is expected to be higher on the cash equivalents than the financing rate that is embedded in the buy-forward contract. If I am successful at that, I will be adding value to the portfolio while maintaining the fundamental exposure to the value of TIPS.

We can also invest outside of the U.S. TIPS market when non-U.S. inflation-linked bonds seem relatively more attractive. Finally, to complete the tool chest, we have the ability to make selective investments in non-inflation-linked bonds. That's something we do when we see relative value in those markets, but we do not do it to a great extent because we always want to maintain for the portfolio the fundamental exposure to the returns of the TIPS market.

Q: What types of investor could benefit from TIPS?

Greer: An investor whose liabilities grow with inflation would benefit from TIPS. That includes investors whose investments are geared toward retirement: individuals with 401(k)s and corporations with defined benefit plans. It also includes endowments and foundations, which have a commitment to fund the operations of an institution or to provide grants year after year, because a grant or endowment money is used to purchase goods and services. So, if endowments and foundations want to maintain the same level of service or the same level of grant-giving, if you will, they need to protect themselves from inflation.

Furthermore, investors who need principal protection because of their liabilities could benefit from TIPS. Endowments, in particular, need a low-risk portfolio because they typically pay out a fixed percentage of their portfolios each year; they need to feel comfortable that they can provide continual funding year after year for the operations of the institutions that they serve. Endowments may therefore benefit from the diversification of TIPS, which might provide smoother levels of value.

See a related article:

Inflation Primer