WIW - WIW: Good For What It Does

2023-07-31 18:32:02 ET

Summary

• Western Asset Infl-Linked Opps & Inc Fd is a fund that primarily invests in Treasury Inflation-Protected Securities.
• As of June 30, 2023, WIW's investment portfolio was heavily skewed towards inflation-linked securities, primarily TIPS.
• I think we are closer than ever to a credit event which would collapse inflation expectations to crash for a moment in time.

Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair. - Sam Ewing.

The Western Asset Inflation-Linked Opportunities & Income Fund ( WIW ) is a fund that primarily invests in Treasury Inflation-Protected Securities ((TIPS)), offering potential hedge against inflation. TIPS are backed by the full faith and credit of the U.S. government, making them one of the safest assets in the world. They also offer a level of protection against inflation, as their value and coupon rate payments are indexed to the Consumer Price Index ((CPI)), a widely used measure of inflation.

For instance, if you invest $1,000 in TIPS at a 1% yield, which translates to an interest payment of $10 per year, and inflation shoots up to 7%, the value of your investment and the interest payment would both increase. The investment would increase in value from $1,000 to $1,070, and the interest payment would rise from $10 to $17. Essentially, TIPS returns are roughly equal to their yields plus inflation.

However, it's important to remember that the performance of TIPS, and by extension WIW, is strongly linked to the rate of inflation. In periods of high inflation, TIPS and WIW would perform exceedingly well. Conversely, in periods of low inflation or deflation, the returns could be much lower.

This is precisely the problem going forward, as I expect significant disinflation and potential deflation to hit.

Examining WIW's Portfolio Composition

As of June 30, 2023, WIW's investment portfolio was heavily skewed towards inflation-linked securities, primarily TIPS. The remainder of the portfolio was spread across a range of other fixed-income assets, including emerging market debt, investment-grade credit, commercial mortgage-backed securities, non-agency mortgage-backed securities ((MBS)), high-yield credit, asset-backed securities, and treasuries.

In terms of currency exposure, WIW's portfolio was primarily invested in U.S. dollar assets, which made up about 93% of the total. The rest was spread across various other currencies.

From a credit quality perspective, the majority of WIW's investments were rated AAA, the highest possible rating, reflecting the fund's focus on high-quality, low-risk assets. The remainder of the portfolio was spread across securities with ratings ranging from AA to CCC, along with a small portion of assets that were not rated.

Analyzing WIW's Distribution Yield and Discount to NAV

One of the attractive features of WIW is its strong distribution yield, which stood at 6.9% as of June 30, 2023. This is significantly higher than the yields offered by bonds in general, all relevant bond sub-asset classes, and equities. The fund's distribution policy is to pay a monthly distribution, with a large special distribution at the end of the year if there are excess funds due to high inflation.

Additionally, WIW was trading at a meaningful discount. This means that investors could purchase shares in the fund for less than the value of the underlying assets, potentially benefiting from capital gains if the discount narrows in the future.

WIW's Performance Review

Examining the past performance of WIW provides useful insights into how the fund has navigated different market conditions and inflationary environments. Over the past three years, during which inflation was quite high, WIW performed reasonably well. However, its long-term performance over the past 10 years, a period characterized by lower inflation, was weaker.

The Risks Associated with WIW

Like any investment, WIW comes with its own set of risks. While TIPS and other inflation-linked securities offer a hedge against inflation, they are not immune to other risks such as interest rate risk, credit risk, and market risk. As interest rates rise, the value of fixed-income securities, including TIPS, tends to fall. This could lead to capital losses for investors in WIW.

Moreover, while TIPS are backed by the U.S. government and are considered low-risk assets, the other securities in WIW's portfolio, such as emerging market debt and high-yield credit, carry higher levels of risk. These securities are more susceptible to factors such as changes in economic conditions, credit risk, and currency risk.

WIW's Outlook and Conclusion

Given the current economic environment and the outlook for inflation, WIW could potentially be a useful tool for investors looking to hedge against inflation. However, the fund's performance will be heavily dependent on the trajectory of inflation and interest rates in the future.

It's not a fund for me only because I'm not convinced inflation persists, and if anything I think we are closer than ever to a credit event which would collapse inflation expectations to crash for a moment in time. Still, it's a good fund for it's objective overall.

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