U.S. Treasury inflation protected securities (TIPS) fell slightly in the third quarter of 2015. Commodity price weakness, low global inflation, and the prospect of the Federal Reserve raising short-term interest rates weighed on the TIPS market. In contrast, fixed rate Treasuries and conventional bonds produced gains as investors sought a safe haven from global equity market volatility and as the Fed delayed its first rate hike since 2006 due to adverse "global economic and financial developments."
The Inflation Protected Bond Fund returned −0.83% in the quarter compared with −1.15% for the Barclays U.S. TIPS Index and −1.92% for the Lipper Inflation Protected Bond Funds Average. For the 12 months ended September 30, 2015, the fund returned −0.82% versus −0.83% for the Barclays U.S. TIPS Index and −2.69% for the Lipper Inflation Protected Bond Funds Average. The fund's average annual total returns were −0.82%, 2.07%, and 3.64% for the 1-, 5-, and 10-year periods, respectively, as of September 30, 2015. The fund's expense ratio was 0.58% as of its fiscal year ended May 31, 2015.
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Our out-of-benchmark allocations to investment-grade corporate bonds and, to a lesser extent, asset-backed securities helped the fund's relative performance. These sectors outperformed TIPS as concerns about global growth, waning inflation expectations, and the possibility of rising U.S. rates weighed on TIPS' performance. During the quarter, we reduced our exposure to TIPS. Toward the end of the period, however, our assessment of the TIPS market improved somewhat, given some recent stabilization of energy prices, a backup in real (inflation-adjusted) yields, and more attractive breakeven spreads.
U.S. inflation is likely to remain low for the foreseeable future. A bounce in commodity prices or a more dovish Fed could change the tone, but, in the short run, TIPS will continue to face headwinds. While the near-term outlook for TIPS is uncertain, the narrow 10-year breakeven spread (the difference between the nominal yield on a 10-year Treasury bond and the real yield on a 10-year TIPS) suggests that TIPS could be somewhat undervalued over a long horizon. Over the near term, TIPS will remain challenged, but we believe investors seeking long-term inflation protection could find current TIPS valuations appealing.