13For most people, periods like 10 or 30 years might seem to be a really long time. But for investors looking to mitigate the impact of inflation on a portfolio, 10 and 30 years are the sweet spots for gauging short- and long-term inflation expectations."When you're looking at inflation from the perspective of an investor, like Credit Suisse does, the best indicators are 10- and 30-year TIPS," says Baldwin Smith, Managing Director and Head of Index and Alpha Strategies at Credit Suisse. "The 30-year 'long bond' works for the long-term because of its far-off maturity. The 10-year gives you a better 'shorter-term' outlook."Inflation is one of the most vexing pieces of financial data because of its ripple effect across the markets and the greater economy. Guessing at which way inflation will move is a pastime (some might say, obsession) of economists and Wall Street analysts. Investors are constantly looking for ways to hedge against the impact that inflation can have on their portfolios. Credit Suisse, in conjunction with Dow Jones Indexes, has introduced new indexes that seek to track the financial markets' pure expectations for inflation. They do so by starting with the TIPS market's built-in expectation for medium and long-term inflation, while simultaneously aiming to remove the interest-rate risk inherent with TIPS. The Dow Jones Credit Suisse Inflation Breakeven Index was launched in the fourth quarter of 2011, joining the Dow Jones Credit Suisse Inflation Index series that came out in 2010."By taking a long position in 10-year TIPS, and a short position in the 10-year Treasury, the goal is to isolate inflation expectations over that time period," says Baldwin. Holders of U.S. government bonds, he says, are extremely inflation-conscious because of the detrimental effect it has on returns. As the market collectively senses that inflation is waxing or waning, the TIPS market quickly and reliably reflects investors' views. He frames the index's strategy using a simple mathematical formula (and explains the index's name):"If you take the yield of the Treasury and subtract the yield of the TIPS with the closest maturity, you get what's called the 'breakeven' rate," he says. "It's an investor's way of saying 'this is where I think inflation will be, and if I am right, I'll "breakeven" and get the same return that I would by buying a regular Treasury of the same maturity.' The index is highly correlated to the breakeven rate, and is structured to be duration neutral, with a goal of minimizing the effect of interest-rate movements on the performance of the index."More accessibility, transparencyWhen the Credit Suisse Index and Alpha Strategies group sat down with Dow Jones Indexes to create this new index, they wanted to make it the most open and accessible product of its kind. "There are similar indexes available to investors, but they have various shortcomings in comparison with ours," he says. "They're not as liquid. They're not readily available to many retail, and even some institutional investors. The breakeven index is readily available to a group of investors who've often been excluded from this opportunity."The indexes are meant to be comprehensible and straight-forward for investors of all types. By offering both 10-year and 30-year indexes, we've given investors a choice that spans two different points on the yield curve," says Baldwin. "These indexes give investors more information with respect to the broad market spectrum."Market InsightMeasuring "Breakeven" InflationBaldwin SmithManaging Director and Global Head of Index and Alpha Strategies, Credit Suisse
14Up or down?When asked about the specter of "deflation," a topic on many people's minds, Baldwin wants to be clear that he does not seek to predict the future. But he acknowledges that "there are always two sides to any trade" and that this index allows people to look at both, depending on their outlook."Any view of inflation-whether it's going up or down or staying put-has its adherents. Our clients use this index because it's designed to accurately measure any given trajectory."Since they were introduced in 1997, TIPS have emerged as the single-most accurate reflection of the markets' inflation expectations. They replaced traditional indicators such as gold, which has its own supply and demand quirks that may have little to do with inflation. But because TIPS have coupons, their prices also track broader nominal interest rate movements. This is a limitation this index is constructed to overcome."The breakeven index attempts to minimize any interest-rate risk. Its primary driver is inflation expectation as embodied by trading on Treasurys and TIPS."The power of inflationDevelopment of the Dow Jones Credit Suisse Breakeven Indexes is a response to the importance of investors having efficient and accurate ways of measuring the effects of inflation expectations in their portfolios. "Inflation has an enormous impact on fixed-income investments, the economy and individuals, especially anyone on a fixed income. It eats away at investments just as it eats away at savings, which affects purchasing power. That's why inflation is always a factor. Always," Baldwin emphasizes."There's a huge stream of market, corporate and political news that affects inflation expectations, and investors need a product that accurately boils all of these factors into a single index. That's the need we set out to fulfill, and I believe we accomplished it."For more information on the Dow Jones Credit Suisse Inflation Breakeven IndexesSM, visit: >> www.djindexes.com/inflationindexes"The breakeven index attempts to minimize any interest-rate risk. Its primary driver is inflation expectation as embodied by trading on Treasurys and TIPS."