The allure of the equity risk premium, which historically outperforms ILBs but delivers periods of painful underperformance, is dominant, pushing ILBs and other defensive assets to the periphery. There is no clear winner among the inflation-hedging assets, and there is space for many of them in a defensive portfolio, Block says. At EISS, ILBs account for a quarter of the fixed income portfolio. When growth assets collapse, such a small allocation to ILBs won’t keep the portfolio afloat. But a longer-term focus could. “If super funds had thought a bit harder, and considered that they might want to have longer-duration bonds because they better match their liabilities, they wouldn’t have suffered as badly as they have in the past two years. But they left their money in short-duration bonds.”

Ideally, funds should split their bond allocation equally between ILBs and nominal bonds, says Tim Unger, head of Watson Wyatt’s strategy team in Australia. But ILB markets here, and perhaps abroad, are too illiquid for such a split to be implemented. “One of the downsides is that there isn’t a lot of historical data for testing. So the case for ILBs is more qualitative than quantitative,” Unger says. Up, up an d away … anytime now Talk of an impending surge in inflation or, more threateningly, stagflation, has turned consultants’ attention towards ILBs.

Unger says Watson Wyatt has always liked ‘linkers’ and the current environment reinforces this view. “Environments that don’t favour risk assets, favour ILBs,” he says. For now, however, inflation is a long-term risk and is not reflected in the price of ILBs or inflation swaps. If economic growth is weak for the medium to long-term, and interest rates stay near 3 per cent, ILBs would be a worthwhile investment if offered at a good price. Peter Fisher, co-head of BlackRock’s fixed income portfolio management group, says the fear of inflation in premature.

“Inflation is coming, but later than you think. It’s about five years out, not one year, because it is a very slow process.” Inflation is usually the consequence of three forces – cheap credit, combined with aggregate rising demand and little spare capacity in the economy – that are not evident in the current environment. “Aggregate demand needs to rise continuously, and that hasn’t happened, while unemployment is still rising. And we’ll know when credit conditions become easier for households and businesses – when banks start lending,” Fisher says.