Adding sustainability to the inflation-linked bond renaissance

The two most discussed concepts in today’s debt capital market could well be the ever-growing relevance of sustainable finance and the return of inflation as a live consideration. FTSE Russell and Refinitiv – now aligned under common ownership – have brought the two together in an innovative new index offering.

Inflation talk has picked up over the course of 2021 after a decade-plus period of near silence. The market debate is whether an inflation spike in the US in particular represents the emergence of a sustained pickup in inflation or is no more than a temporary phenomenon driven primarily by pandemic-related supply-chain disruption.

There can no longer be any doubt that anecdotal evidence of labour-market pressure and constricted supply of certain goods – for instance new and second-hand cars – is feeding through to near-term inflation prints. US CPI inflation hit 5 per cent annualised in May this year, outstripping even a relatively bullish market consensus expectation of 4.7 per cent.

One possible scenario is that the post-financial-crisis period – in which record fiscal and monetary stimulus resolutely failed to spark price growth – has conditioned market participants into a false sense of security about the spectre of inflation. Inflation expectations for H2 2021 have actually eased in the US, even in the wake of the high May CPI print, largely because market consensus remains that the spike will not be protracted.

Whether the inflation bulls or bears are proved to be correct, there is clearly a groundswell of global investor interest in exploring inflation protection, accompanied by a pickup in issuance from a range of sovereign borrowers.

“Inflation prints have been noticeably high, overshooting the 2 per cent target in the UK and getting up to 5 per cent in the US,” says Scott Harman, global head of fixed income product management at FTSE Russell in London. “This has manifested in the market in the form of large inflows to inflation-linked funds – year-to-date flows have already exceeded 2020.”

Issuance has also increased globally. FTSE Russell data reveal the market capitalisation of its World Inflation-Linked Securities Index reached nearly US$3.9 trillion equivalent by the end of January this year, up by US$1.2 trillion in just two years.

FTSE Russell and Refinitiv are both owned by the London Stock Exchange Group and Refinitiv offers pricing data on all the bonds underlying FTSE Russell indices. “Our fixed-income business offers pricing on 2.7 million bonds and OTC derivatives, and the FTSE Russell indices are leveraging off this work,” says Chris Young, Asia sales director, enterprise data solutions at Refinitv in Sydney. “By using the synergies between FTSE Russell and the Refinitiv pricing sources investors are able to eliminate any tracking error.”

Harman agrees that this depth of pricing information helps FTSE Russell respond to investors’ increasingly complex index requirements. He says the company has in the past year or two produced its most complex ever solutions, in response to investor needs – including in the area of sustainability.


As investor engagement with inflation-linked exposure grows it is accompanied by the driver of a requirement for sustainability integration. Harman tells KangaNews: “We have of course seen increasing demand for inflation-linked indices, but also for thematic inflation-linked products. We were given the challenge of trying to index the inflation-linked market in a sustainable way by our end clients, who want more sustainable solutions across their investments.”

This drive to align growing interest in inflation exposures with climate-risk management led FTSE Russell to develop its Climate Risk Adjusted World Inflation-Linked Securities Index. The challenge was how to deliver this alignment, given there is no natural correlation between a sovereign’s volume of linker issuance and its climate bona fides.

Harman explains: “We looked at the most commonly used approach in fixed income – negative screening – but we concluded that this does not work in a concentrated government-bond universe. Instead, we approached index construction from a tilting basis.”

The index weights sovereign linker issuance initially by volume on issue and then applies the tilting methodology. This adjusts index weights according to each country’s relative exposure to climate risk, specifically its resilience to and preparedness for the risks of climate change.

The tilt means, for instance, that Sweden – a relatively small inflation-linked issuer but what Harman calls a “stellar performer” on climate risk – accounts for a weighting of 1.3 per cent in the index while representing just 0.7 per cent of its market capitalisation. The US, by contrast, has a substantial underweight – making up 29.2 per cent of the index despite its issuance contributing 36.7 per cent of market capitalisation.