On the heels of a difficult second quarter, U.S. Treasuries stabilized in the third quarter. Long-term nominal Treasury yields rose through early September but fell sharply for the month as the Federal Reserve surprised many investors with its mid-September decision to delay the tapering of its asset purchases. Treasury inflation protected securities (TIPS), which have lagged nominal Treasuries by a wide margin this year amid muted inflation and concerns around tighter monetary policy, outperformed their nominal counterparts for the quarter. Short- and intermediate-term TIPS produced the best results, as the real (inflation-adjusted) yield curve steepened, with yields of maturities less than 14 years generally declining.
The Inflation Protected Bond Fund returned 0.74% in the quarter compared with 0.70% for the Barclays U.S. TIPS Index and 0.72% for the Lipper Inflation Protected Bond Funds Average. For the 12 months ended September 30, 2013, the fund returned −6.21% versus −6.10% for the Barclays U.S. TIPS Index and −5.51% for the Lipper Inflation Protected Bond Funds Average. The fund's average annual total returns were −6.21%, 4.86%, and 4.73% for the 1-, 5-, and 10-year periods, respectively, as of September 30, 2013. The fund's expense ratio was 0.56% as of its fiscal year ended May 31, 2013.
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The fund invests mostly in TIPS (more than 91% of assets as of September 30) to protect against higher actual or expected inflation. We diversify the portfolio into other fixed income securities-such as investment-grade corporate bonds and mortgage-backed securities (MBS)-to earn attractive income, especially when inflation is benign or the cost of inflation protection is expensive. As a means of further diversification, we also allocate to inflation-indexed securities in non-U.S. markets that we feel offer more attractive real yields and inflation dynamics relative to their U.S. counterparts. During the quarter, our allocations to MBS and shorter-dated corporate bonds helped our performance. Also, an overweight to longer-term TIPS allowed us to take advantage of the positive real yields now offered by these maturities. Our investments in Mexican inflation-linked securities helped performance, but the benefits were reduced by a weaker peso versus the dollar.
We believe TIPS remain in a transition period, as the bond market prices in the prospect of a new Fed regime in which longer-dated real interest rates are pushed back into positive territory. Even with real TIPS rates at low positive levels, valuations in the sector remain stretched by historic standards, and various factors-including modest wage growth and minimal corporate pricing power-are likely to act as near-term headwinds. At the same time, investors' concerns about the Fed's ballooning balance sheet and the potential long-term effects of an extended period of low nominal interest rates remain valid and continue to argue in favor of having some exposure to inflation protected securities. Given the increased volatility in U.S. interest rates, we have reduced our currency risk but will look for tactical non-U.S. opportunities as rates stabilize.