U.S. Treasury inflation protected securities (TIPS) declined in the second quarter of 2015. Real yields on TIPS and nominal Treasury yields increased as the economy strengthened following a slight first-quarter contraction. Long-term TIPS held up better than Treasuries with comparable maturities, as nominal 10- and 30-year Treasury yields rose more than yields on 10- and 30-year TIPS. The Federal Reserve refrained from raising short-term rates but signaled that rate hikes will likely commence by the end of the year if labor market conditions continue to improve.
The Inflation Protected Bond Fund returned −1.08% in the quarter compared with −1.06% for the Barclays U.S. TIPS Index and −0.90% for the Lipper Inflation Protected Bond Funds Average. For the 12 months ended June 30, 2015, the fund returned −1.87% versus −1.73% for the Barclays U.S. TIPS Index and −2.92% for the Lipper Inflation Protected Bond Funds Average. The fund's average annual total returns were −1.87%, 2.78%, and 3.72% for the 1-, 5-, and 10-year periods, respectively, as of June 30, 2015. The fund's expense ratio was 0.59% as of its fiscal year ended May 31, 2014.
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During the quarter, we reduced the portfolio's longer-duration TIPS exposure in favor of intermediate-term TIPS. As inflation expectations rebounded from first-quarter lows, the 10-year TIPS breakeven spread rose to a more fairly valued level, so we rotated down the curve. Our curve positioning contributed to performance, most notably an underweight to longer maturities as rates moved higher across the curve. To diversify the portfolio, we maintained allocations among short-term fixed rate corporate bonds, asset-backed securities, and commercial mortgage-backed securities that tend to have higher yields than TIPS. These allocations detracted from our performance during the quarter.
Unfortunately, the real yields on TIPS, like many fixed income securities caught in the grip of the Fed's current zero interest rate policy, are hardly compelling. With real yields on shorter-term TIPS below 0%, investors effectively remain willing to pay a premium to receive inflation protection over the next few years. The challenge for the Fed as it normalizes monetary policy will be to determine the appropriate pace, timing, and magnitude of rate increases so as to not stifle the improving economy. We believe the Fed may be willing to tolerate higher inflation and restrain its rate hikes so that the economic recovery continues. This would be a supportive environment for TIPS. On the other hand, if the Fed starts raising nominal interest rates aggressively, real rates will increase also, and the environment for TIPS will be more difficult.