Gates Foundation hedges its holdings

Microsoft Corp. co-founder Bill Gates' charitable foundation holds more than $2 billion in inflation-protected Treasury notes as a hedge against a possible resurgence in prices, his money manager said yesterday.

Michael Larson, who handles the billionaire's personal investments and those of the Bill & Melinda Gates Foundation, said he acquired the Treasury Inflation Protected Securities -- or TIPS -- when inflation and demand for TIPS were low.

"The best time to buy (TIPS) is in a period of low inflation -- before inflation increases," Larson said in an interview conducted through the Internet.

"TIPS represent a large portion of our portfolio -- both because we expect the security to produce positive returns in an inflationary environment and because they help diversify away risk."

Demand for TIPS has risen as the Federal Reserve allows more inflation in the economy. The current yield on 10-year Treasury notes is about 220 basis points higher than the yield on TIPS that mature in the same number of years as the spread widened in recent months from 160 basis points. Each basis point equals 0.01 percentage points.

The current spread signals that investors expect an annual inflation rate of 2.2 percent over the rest of this decade. Investors who foresee even higher inflation would benefit by investing in TIPS at that price, while those who expect lower inflation should buy regular Treasury bonds, said Alan Heuberger, who helps Larson manage the Gates Foundation's investments.

"The yield spread between TIPS and nominal bonds provide a market expectation of future inflation rates," Heuberger said. "Even if your view on future inflation is relatively benign, TIPS still might make sense in an overall portfolio."

The Gates Foundation holds more than $2 billion of the securities, which would equal about 8 percent of its total endowment, Larson said.

Cascade Investment LLC, the company that Larson uses to make investments on behalf of Gates, doesn't hold any TIPS, according to the money manager.

Larson, who works at an office in Kirkland, keeps a low profile on Wall Street, picking stocks and bonds for just a few investors.

Two of those clients are Gates, who ranks as the richest person in the world, with an estimated fortune of $43 billion at the end of 2002, according to Forbes Magazine, and the Gates Foundation, with an endowment of about $25 billion.

In the past, Larson has been reluctant to talk about his investments, some of which are disclosed in quarterly filings with the Securities and Exchange Commission. He agreed to discuss the inflation-protected bonds, saying that "the more people learn about TIPS, the better off the financial system is."

Currently, there are about $166 billion of TIPS outstanding, compared with the $3.4 trillion market for Treasuries. Institutions have been reluctant to invest in TIPS because of the low level of trading in the securities, making it more difficult to buy and sell the debt.

"The TIPS market has been notoriously illiquid," said Anthony Crescenzi, chief bond market strategist at Miller Tabak + Co. "Institutions prefer owning a liquid instrument if they need a quick exit."

The $72 billion Pimco Total Return Fund, which ranks as the world's biggest bond mutual fund, recently raised its TIPS holdings to about 10 percent of assets, according to portfolio manager Bill Gross.

The Treasury Department first sold TIPS in 1997, offering investors a fixed coupon along with adjustments to the principal amount of their bonds based on changes in the government's consumer price index.

So, if the price index were to rise 3 percent in a year, the face amount of a TIPS would rise to 103 from 100, and the government would calculate the bond's interest payments using the higher principal amount.

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