PIMCO REAL RETURN BOND FUND

PIMCOs Real Return Bond fund (1-888-877-4626) is real return sensitive. (A bond's real return is what's left over after you've subtracted the rate of inflation from the bond's yield. So, if a bond has a fixed interest rate of say 6 percent on it and inflation is running at 3 percent, the real return on that bond would be 3 percent that year.) What makes it so is that it invests the bulk of its assets in TIPS, Treasury Inflation-Protected Securities. Those are bonds that, along with their interest rate or "coupon", adjust their total annual yield for changes in the inflation rate as measured by the CPI --Consumer Price Index.

John Brynjolfsson has been portfolio manager on the PIMCO Real Return Bond Fund since its inception in January 1997. Along with being a TIPS pro---he's even written a book on the subject---he's not shy about reminding investors about the reality of inflation.

"Inflation in the U. S., ever since World War 11, has been positive, " says Brynjolfsson. "And recently it has definitely picked up."

I caught up with Brynjolfsson in early July. What follows are some of his comments about the fund:

Q: Do you see inflation picking up?

A: Definitely. The price of oil has about tripled over the past 18 months, the price of natural gas is at all time highs, the price of electricity is accelerating, the prices of aluminum up and all of these things are the most inflation sensitive indicators that we have.

Q: With inflation moving upward, what can your fund do for investors?

A: The nice thing about our fund is that, as a long-term saver, you don't have to worry about the gyrations of inflation, prices and interest rates because this inflation-indexed bond fund will generate an ample return. By that I mean, a return that's higher than the return on other types of Treasuries.

Q: How so?

A: As inflation goes up, the return on the bonds is enhanced by the higher inflation accruals. Even if inflation remains flat or falls say from its current 3 percent level down to 2, the returns will still be attractive.

Q: Who issues TIPS?

A: The U.S. Treasury is a very large issuer, corporations may also issue them (called corporate inflation-index securities) and foreign governments issues TIPS as well.

Q: How many bonds are in the fund?

A: There are over 100. We use Treasury TIPS, primarily. We also own some corporation inflation-index bonds and some traditional floating rate notes issued by corporations. We are allowed up to 10 percent in below investment grade bonds, however, currently about 5.4 percent of the fund is invested in them. Then, we are allowed to have non-dollar bonds, meaning bonds that are issued in a foreign currency and that would be about 2 percent.

Q: Not much cash.

A: No. Currently the U.S Inflation Index bonds are so attractive that the portfolio is fully invested.

Q: What are the risks that investors will take going into the Real Return Bond Fund?

A: The risk is what we call "opportunity cost." Opportunity cost means that in this fund, you will receive what I would call a substantial return, but that doesn't mean that there may not be higher returning assets out there.

So, despite what's been happening in the stock market so far this year, there is no guarantee that equities won't generate 20 percent returns over the next year. If they do, by merely settling for a 7 percent return in the Real Return Bond Fund, you will have suffered what is known as an opportunity cost. Meaning, you didn't lose money, you just lost the opportunity to make more money.

Q: Who is the fund ideally suited for?

A: First, they are best for individuals either approaching retirement or in retirement. Meaning, conservative investors who have a nest egg that they want to protect.

Secondly, they are ideal to hold in tax-sheltered vehicles, like a 401(k)s or IRAs, because the bonds are taxable and not only are you taxes on the coupon, but you also are taxed on the inflation accrual. And that can be onerous. So, consider owning the fund in a tax-deferred vehicle.