Why Bill Gates Is Buying Inflation Funds

23-Oct-2011

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An eternal optimist, Liu-Yue built two social enterprises to help make the world a better place. Liu-Yue co-founded Oxstones Investment Club a searchable content platform and business tools for knowledge sharing and financial education. Oxstones.com also provides investors with direct access to U.S. commercial real estate opportunities and other alternative investments. In addition, Liu-Yue also co-founded Cute Brands a cause-oriented character brand management and brand licensing company that creates social awareness on global issues and societal challenges through character creations. Prior to his entrepreneurial endeavors, Liu-Yue worked as an Executive Associate at M&T Bank in the Structured Real Estate Finance Group where he worked with senior management on multiple bank-wide risk management projects. He also had a dual role as a commercial banker advising UHNWIs and family offices on investments, credit, and banking needs while focused on residential CRE, infrastructure development, and affordable housing projects. Prior to M&T, he held a number of positions in Latin American equities and bonds investment groups at SBC Warburg Dillon Read (Swiss Bank), OFFITBANK (the wealth management division of Wachovia Bank), and in small cap equities at Steinberg Priest Capital Management (family office). Liu-Yue has an MBA specializing in investment management and strategy from Georgetown University and a Bachelor of Science in Finance and Marketing from Stern School of Business at NYU. He also completed graduate studies in international management at the University of Oxford, Trinity College.







By BRETT ARENDS, Smart Money,

If you’re retired, or nearly retired, you probably want three things from your investments: Safety of principal, a reasonable rate of interest, and some security against the risks of inflation down the road.

Good luck with that.

Developments in the financial markets, and the Federal Reserve’s policies, have driven down interest rates and closed off most of your options.

What can you do?

Here’s something intriguing. Microsoft (MSFT: 27.04, -0.09, -0.33%) founder Bill Gates has been quietly taking advantage of a little-known investment on the stock market that may satisfy all three conditions. And it’s open to anyone.

Before we take a look at that, let’s look at the conundrum facing millions of older investors.

Stocks don’t offer safety of principal (although a basket of high-quality blue chips offer a pretty reasonable amount of security over the course of, say, five or more years).

Certificates of deposit, money-market funds and short-term bonds don’t offer a reasonable rate of interest. One-year CDs are paying about 1% — compared to official inflation currently running at 3.8% — and shorter-term deposits are paying even less.

And if you buy longer-term bonds instead, to earn higher interest, you are putting yourself at risk from inflation. Even 30-year Treasurys yield little more than 3%.

This problem has been driving many investors into a fourth option: Inflation-protected Treasury bonds, known as TIPS.

Until recently these were among my favorite investments for conservative investors (and indeed for most of us). TIPS are bonds issued by Uncle Sam, but unlike regular bonds their yield rises and falls with inflation. As recently as this spring the so-called “real” yield on long-term TIPS bonds, which means the interest rate on top of inflation, was nearly 2%. That was a pretty good deal.

No longer. TIPS bonds have rocketed in price — as investors have stampeded into the last lifeboat available.

Bonds are like seesaws. When the price goes up, the interest rate goes down. Anyone buying TIPS bonds today is locking in meager returns — or worse.

The five-year TIPS bond actually sports a negative “real” yield of half a percent a year. Put another way: Anyone buying that bond today and holding it for five years is guaranteed to lose 3% of their purchasing power.

You have to buy TIPS bonds of at least 10 year’s maturity to earn a return ahead of inflation, and even there it’s a paltry 0.3% a year.

What’s worse is that the inflation rate used to calculate the yield on TIPS bonds is the official consumer price index. The CPI seriously flatters the true inflation picture for all of us. And it especially understates inflation for older citizens — precisely the people most likely to buy TIPS bonds.

The U.S. Labor Department privately calculates a separate CPI index for senior citizens, known as CPI-E, and it typically runs about 0.3% a year above the regular CPI. If you’re buying a TIPS bond with a “real” yield of 0.3%, that wipes out all your profits.

So what is Bill Gates doing?

The Microsoft founder, and one of the world’s richest men, has been quietly building his position in two closed-end funds that invest in inflation-protected bonds. What makes these funds intriguing is that they are effectively offering you a way to buy inflation-protected bonds at 11% off. For bonds, that’s a hefty saving.

The funds are Western Asset/Claymore Inflation-Linked Securities (WIA: 12.79, 0.13, 1.03%) and Western Asset/Claymore Inflation-Linked Opportunities & Income (WIW: 12.75, 0.16, 1.27%).

Closed-end funds are curious hybrids — they are regulated mutual funds that otherwise look like company stocks. You buy and sell them on the stock market. And they only issue a finite number of shares, so investors wanting to get in need to buy shares from investors who want out.

One aspect of closed-end funds is that the stock price doesn’t always correlate with the underlying value of the fund’s investments. You can have a closed-end fund holding $1 a share in pure cash, and yet the shares can be changing hands on the stock market for 90 cents or even less.

In the case of WIA and WIW, the shares — around $12.50 for both funds — are down to 89 cents on the dollar. This discount is unusually high. As recently as last winter the shares were trading at around a more typical 95 cents on the dollar. That means you get more income for your investment dollar, and might get some extra capital gains if the gap narrows again.

After investing several million dollars more in the two funds in recent months, Gates now holds $106 million in WIW and $56 million in WIA through his personal investment vehicle, Cascade Investments. It’s just a drop in his $40 billion fortune.

The funds invest in a mix of bonds, nearly all of them inflation-linked. This includes Treasury bonds, inflation-linked bonds issued by foreign governments (such as France), and corporate bonds. They are all investment grade, 90% or so triple-AAA rated. Both offer monthly distributions of about 3.2%. (Closed-end fund distributions can include capital as well as income).

The funds are distributed by Guggenheim Partners and the portfolios are managed by veteran fund managers Legg Mason. Guggenheim spokesman William Korver said the two funds pursue similar strategies, though WIW has a little more flexibility in its portfolio. Both have the ability to borrow against their investments, though neither do at the moment, he said. Korver said there was no particular reason to explain the discounts to net assets right now.

Thomas Herzfeld, the closed-end fund expert, is a fan of both funds and they have decent track records.

They may offer a way into TIPS and TIPS-type bonds without paying today’s high, desperation-level prices for TIPS. As ever, you need to kick the tires yourself before you buy.


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