Treasury inflation protected securities (TIPS) produced strong absolute returns in the first quarter. Despite the onset of Federal Reserve tapering of its asset purchases, longer-term real (inflation-adjusted) and nominal Treasury bond yields declined in response to economic data reflecting a harsh winter, slowing growth in China, and geopolitical tensions involving Russia and Ukraine. Real yields among shorter maturities increased slightly in response to comments from new Fed Chair Janet Yellen that the central bank might consider raising short-term rates about six months after the Fed stops purchasing securities. Headline inflation showed signs of firming but remained well below the Fed's long-term 2% target. Market expectations for inflation were roughly the same as they were at the end of 2013.
The Inflation Protected Bond Fund returned 2.02% in the quarter compared with 1.95% for the Barclays U.S. TIPS Index and 1.60% for the Lipper Inflation Protected Bond Funds Average. For the 12 months ended March 31, 2014, the fund returned −6.62% versus −6.49% for the Barclays U.S. TIPS Index and −5.81% for the Lipper Inflation Protected Bond Funds Average. The fund's average annual total returns were −6.62%, 4.51%, and 4.06% for the 1-, 5-, and 10-year periods, respectively, as of March 31, 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 (91% of assets as of March 31, 2014) to protect against higher actual or expected inflation. We diversify the portfolio into other fixed income assets, such as investment-grade corporate and mortgage-backed securities, to earn attractive income, especially when inflation is benign or the cost of inflation protection is expensive. We may also allocate to inflation-indexed securities in non-U.S. markets that we feel offer more attractive real yields and inflation dynamics versus their U.S. counterparts. During the quarter, allocations to commercial mortgage-backed securities and shorter-dated investment-grade corporate bonds helped relative performance. Overweighting longer-term TIPS was also beneficial. We are underweighting intermediate-term TIPS, whose real yields are still mostly negative, because we believe they are vulnerable to rising rates in the months ahead.
We believe that the tapering of Fed asset purchases, which should conclude by the end of 2014, is mostly priced into the U.S. government bond market. That said, interest rates could continue to rise if the economy or inflation picks up, or if the first fed funds rate increase seems likely to occur sooner than expected. In light of last year's poor performance of TIPS, we believe the long-end of the market may be a bit oversold. Valuations among shorter-term TIPS, however, are still somewhat stretched, and short-term real yields could rise as we approach the first Fed rate hike. While near-term inflation could remain low, investors' concerns about the potential long-term effects of an extended period of low nominal interest rates continue to argue in favor of having exposure to inflation protected securities.