U.S. Treasury inflation protected securities (TIPS) produced mild returns in the first quarter amid decelerating economic growth, weak inflation readings, and declining real (inflation-adjusted) interest rates. Fixed rate Treasuries outperformed TIPS with comparable maturities as nominal yields fell. Strong foreign demand for U.S. government bonds, whose yields are higher than sovereign debt yields in Europe and Japan, was a contributing factor. The Federal Reserve kept short-term interest rates very low but suggested in a statement following its mid-March policy meeting that an initial rate hike may occur later this year, depending on economic data.
The Inflation Protected Bond Fund returned 1.26% in the quarter compared with 1.42% for the Barclays U.S. TIPS Index and 1.01% for the Lipper Inflation Protected Bond Funds Average. For the 12 months ended March 31, 2015, the fund returned 2.65% versus 3.11% for the Barclays U.S. TIPS Index and 1.00% for the Lipper Inflation Protected Bond Funds Average. The fund's average annual total returns were 2.65%, 3.77%, and 4.12% for the 1-, 5-, and 10-year periods, respectively, as of March 31, 2015. The fund's expense ratio was 0.59% as of its fiscal year ended May 31, 2014.
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The fund invests mostly in TIPS to protect against higher actual or expected inflation. The focus of this allocation is in longer-term TIPS, which offer positive real yields. During the quarter, our preference for longer-dated TIPS benefited as negative real yields remained at the front end of the curve. However, our duration posture worked against us as real rates declined. To diversify the portfolio, we maintained allocations among short-term fixed rate corporate bonds, asset-backed securities (ABS), and commercial mortgage-backed securities (CMBS) that tend to have higher yields than TIPS. These investments generally outperformed TIPS, thus helping our performance. Our investments in Brazilian and Canadian inflation-indexed securities marginally added to our results, but weakness in the Brazilian real and Mexican peso offset the gain.
In the U.S., headline inflation readings remain subdued, primarily due to lower oil prices and a stronger dollar. However, core inflation has improved in recent months. The Fed has suggested that it will look through what it considers "transitory" price weakness in assessing conditions for a rate liftoff. As such, our expectation remains for the first rate hike to occur in mid- to late 2015. We maintain our current TIPS positions and expect an improving market environment over the near term. However, we remain cautious because a Fed rate hike, without accompanying inflation pressures, could weigh on the TIPS market.