Treasury inflation protected securities (TIPS) produced strong returns in the second quarter. Even though the Federal Reserve continued tapering its asset purchases, long-term interest rates extended their first-quarter decline in anticipation of new stimulus measures in Europe. This drove eurozone interest rates lower and made U.S. rates relatively more attractive, which supported increased buying interest in Treasuries. At the end of June, real yields on TIPS maturing in seven to 10 years were barely in positive territory, while two- and five-year real yields remained below 0%. However, inflation has been showing signs of gaining traction in recent months, particularly with regard to wages and food prices. This could eventually translate into higher inflation adjustments for TIPS.
The Inflation Protected Bond Fund returned 3.48% in the quarter compared with 3.81% for the Barclays U.S. TIPS Index and 3.18% for the Lipper Inflation Protected Bond Funds Average. For the 12 months ended June 30, 2014, the fund returned 4.01% versus 4.44% for the Barclays U.S. TIPS Index and 3.96% for the Lipper Inflation Protected Bond Funds Average. The fund's average annual total returns were 4.01%, 5.13%, and 4.77% for the 1-, 5-, and 10-year periods, respectively, as of June 30, 2014. 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 to protect against higher actual or expected inflation. Our overweight to longer-term TIPS benefited from the decline in long-term rates. To augment income, we maintain allocations to corporate, asset-backed, mortgage-backed, and commercial mortgage-backed securities. The maturities of these holdings are concentrated at the front end of the yield curve. These securities typically yield more than TIPS with comparable maturities, and they appreciated as the yield differences between higher- and lower-quality issues narrowed. When appropriate, we add exposure to non-U.S. inflation-linked securities and to foreign currencies that we expect to appreciate.
The Fed is on track to conclude its asset purchases in October. Assuming that the economy continues to grow, we believe the Fed will begin to increase short-term rates around the middle of 2015. While this could exert upward pressure on nominal long-term rates, we believe rate increases will not be as sharp as they were in 2013. As we approach the first rate hike, we would expect intermediate-term rates to rise, especially if inflation measures continue to trend higher. Despite the recent rally, long-term TIPS still offer value. Of course, if the rate of inflation decreases or if real interest rates increase as they did in 2013, TIPS would be likely to struggle.