Special Feature Article on the
Inflation Protection Fund

Why invest in the Inflation Protection Fund?

The Inflation Protection Fund (IPF) provides participants with an opportunity to protect the value of their investments from unanticipated inflation. It also provides another source of diversification for participant fund balances managed by the General Board. For example, when stocks performed poorly after the technology stock bubble burst in 2000, the well-diversified inflation protection assets performed very well. While there is no guarantee that inflation protection assets will do well in weak stock markets going forward, the General Board believes that they are prudent long-term investments for its participants. The long-term goal of the IPF is to achieve an investment return of 2% over the rate of U.S. inflation.

What metric is typically used to measure inflation?

In the United States, the key economic bellwether for tracking inflation is the Consumer Price Index for All Urban Consumers (CPI). The CPI is published monthly by the Federal Government Bureau of Labor Statistics.

How has the Inflation Protection Fund performed?

Since the inception of the IPF at the beginning of 2004, the fund has produced a compounded rate of return of 3.9% after all investment management and fund administration expenses have been applied. During this period, inflation as measured by the CPI grew at an average annual rate of 3.1%.

The General Board began investing in inflation protection securities in 1998, and these types of investments have produced an annualized rate of return of 7.4% compared to an average inflation rate of 2.6% through 2006.

The IPF did not attain its goal (beating inflation by 2%) during the three years that the General Board has offered the fund to participants. However, the General Board fully expects the fund to meet this goal for long periods, as evidenced by the comparative performance for the eight years that the General Board has invested in these types of securities.

What are the risks of investing in the Inflation Protection Fund?

The fund’s short-term performance could vary significantly from the short-term inflation rate. Other factors besides inflation affect short-term performance. For example, prospects for higher returns in other asset classes such as stocks may result in an oversupply of inflation protection securities, which will negatively influence market prices for these types of securities.

Additionally, the fund invests 10% of its assets in commodities futures contracts. The General Board believes that investing in commodities represents a good proxy for inflation and provides additional diversification for investors. However, commodity prices tend to be more volatile and periodically experience wide swings that could negatively influence the performance of the fund.

What factors affect the price of inflation protection securities?

There are two factors that affect the price of Inflation Protection securities. The first is a premium (also known as the real rate of return) which investors expect above the rate of inflation. The real rate of return constantly fluctuates based on the collective demands and expectations of potential investors.

The second component is the actual rate of inflation. The U.S. Treasury is responsible for issuing Inflation Protection Securities (also known as TIPS -) and agrees to increase the redemption value (also known as par value) of the bonds based on the annual change in the Consumer Price Index. (In no case will par value adjust below the price at which the bonds were issued). While the face value of a TIPS bond will never fall below the issue price, should the U.S. experience deflation (declining prices) after a period of inflation (rising prices), the par value could decline until it reaches the price at which the bond was issued (typically $1,000).