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Inflation-Linked Bonds as a Separate Asset Class: Evidence from Emerging and Developed Markets

One of the key goals of strategic asset allocation is protection against inflation. High inflation eats up real returns, causing a damaging effect on a portfolio of bonds and equities. Inflation-linked bonds (ILBs) were introduced to shield the purchasing power of a portfolio from inflationary conditions by linking portfolio returns to inflation, over a bond’s life term. The current research evaluates the acceptability of ILBs as a separate asset class and as an inflation hedge. It uses data from four emerging and four developed markets for a period of five years, that is, 2011–2016. The study employs multiple regression, cross-correlations and mean-variance spanning techniques to demonstrate the abovementioned benefits of ILBs. The findings of the study establish an advantage of excess returns provided by ILBs over nominal bonds under varying inflationary conditions. An improvement in mean-variance efficiency is found when ILBs are added to a portfolio. Overall, the study contributes to the body of knowledge by suggesting that ILBs can be included in a portfolio to hedge, as well as to improve its strategic asset allocation.