Exploring inflation linked investments

By Damon Frith, Wealth Editor, NAB Private Wealth

Inflation is a double-edged sword. If moderate and consistent, it can facilitate economic growth by stimulating business investment and consumer spending. However, when prices rise, the real value of money falls, eroding the purchasing power of savings and investment returns. Inflation‑linked investments aim to counter this effect by providing returns that rise with inflation.

Inflation‑Linked Bonds: A primary inflation hedge

Inflation‑linked bonds are designed specifically to track inflation, adjusting their cashflows in line with consumer‑price indices.

Inflation‑linked bonds are government or corporate‑issued securities whose principal value and interest payments rise with inflation. They are the only investment type where the link to inflation is explicit and formula‑driven. Government issued inflation-linked bonds are guaranteed by sovereign issuers.

How They Work

Inflation‑linked bonds adjust their principal value based on changes in a consumer‑price index (CPI). Interest is then paid on this inflation‑adjusted principal. This structure ensures two things:

• The investor receives a known real yield (the return after inflation).
• The nominal value of the bond rises with inflation, preserving purchasing power.

Australian Capital Indexed Bonds (CIBs)

In Australia, the primary inflation‑linked securities are Capital Indexed Bonds (CIBs) issued by the Commonwealth Government. They are tied to the Australian CPI and provide the purest hedge for domestic inflation.

CIBs are widely used by institutions and wealth managers because they:

• Track Australian inflation directly
• Offer sovereign credit quality
• Provide predictable real returns
• Fit naturally into domestic portfolios without currency risk

For Australian investors, CIBs are generally a straightforward and effective inflation‑linked investment.

US Treasury Inflation‑Protected Securities (TIPS)

TIPS are the largest and most liquid inflation‑linked market globally. They operate similarly to CIBs, adjusting principal and coupon payments in line with US CPI.

TIPS are attractive because of:

• Deep liquidity
• Transparent pricing
• Broad maturity spectrum
• Strong institutional participation

However, for Australian investors, TIPS introduce USD currency exposure. That exposure can be hedged, or if an investor has conviction that the direction of the AUD-US dollar relationship could work in their favour, be used to enhance returns.

UK Index‑Linked Gilts

The UK also issues inflation‑linked gilts tied to the Retail Price Index (RPI). These securities are known for their very long maturities and strong institutional demand. However, they are generally less attractive to Australian investors due to currency exposure and high duration risk. They are accessible through global bond funds but are not typically a core holding in Australian portfolios.

Beyond Bonds: Indirect inflation‑linked investments

While inflation‑linked bonds provide the most direct protection, several other asset classes offer indirect inflation hedging through economic behaviour, pricing power, or supply‑demand dynamics. These assets do not track CPI, but they often perform well during inflationary periods.

Infrastructure

Infrastructure assets, such as toll roads, utilities, airports, and energy networks, often have inflation‑linked revenue structures. Many regulated utilities adjust prices based on CPI, and long‑term concession agreements frequently include inflation escalators.

Key advantages:

• Stable, long‑duration cashflows
• Often explicitly inflation‑indexed
• Essential services with strong pricing power

Infrastructure is widely used by pension funds and wealth managers as a long‑term inflation hedge, especially when combined with inflation‑linked bonds.

Commodities

Commodities are highly sensitive to inflation because they sit at the start of the production chain. When inflation rises, particularly cost‑push inflation, commodity prices often increase.

Commodities offer:

• Strong performance during inflation spikes
• Diversification benefits
• Direct exposure to supply‑demand imbalances

However, they are volatile and cyclical, making them a tactical rather than structural inflation hedge.

Real Assets

Real assets derive value from physical scarcity and utility. Their replacement costs rise with inflation, supporting valuations.

Examples:

• Real estate
• Farmland
• Timberland
• Natural‑resource rights

These assets provide inflation protection through:

• Rising rents
• Increasing land values
• Higher replacement costs
• Long‑term demand for essential resources

They are less precise than inflation‑linked bonds but generally offer strong long‑term inflation resilience.

A Multi‑Layered Inflation Strategy

A blended inflation‑protection strategy typically combines:

1. Inflation‑linked bonds (primary, direct hedge)
2. Infrastructure (stable, inflation‑linked cashflows)
3. Commodities (tactical inflation sensitivity)
4. Real assets (long‑term inflation resilience)

Conclusion

Inflation‑linked investments are essential tools for preserving purchasing power in a rising‑price environment. At the centre of this ecosystem are inflation‑linked bonds, the only instruments that directly track inflation. For Australian investors, Capital Indexed Bonds offer the most precise domestic protection, while TIPS provide US currency exposure.

Beyond bonds, infrastructure, commodities, and real assets offer broader inflation resilience through pricing power and economic behaviour. Together, these assets form a comprehensive inflation‑protection framework that can mitigate a wide range of inflation regimes.

To discover more call 1300 683 106 or email us on investordesk@nab.com.au

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