Deutsche Bank is launching an index that will give investors and asset managers a convenient way to hedge against inflation in non-Japan Asia.

The index, which can be bought in a variety of ways such as through swaps or principal-protected notes, aims to track the IMF's non-investable index of Asian inflation, which is an aggregate of inflation rates in Asia weighted by economic size and purchasing power.

After running simulations against inflation data since 2002, Deutsche says its Asian Inflation Proxy Index tracks the IMF benchmark with an error of less than 1% û giving a return of 3.92% a year. This is quite a tricky feat to pull off given that ex-Japan Asia lacks an active inflation-linked bond market, even though there is clearly demand to buy inflation, both as a hedge and as a diversification tool within a balanced investment portfolio.

"Inflation has become important to people, it's come back into their minds," says Michael Parker, head of options trading in Deutsche's Asian global rates team. "So what the index does is allow people to put a potential hedge on to their books."

To achieve this, the index starts by investing in inflation-linked bonds issued in Europe, the US and Japan. This works reasonably well because inflation is becoming an increasingly global phenomenon, according to Parker.

But G3 inflation does not provide a very accurate proxy by itself. "Trading inflation-linked bonds in the global markets can provide a pretty good hedge, but what allows us to give this low tracking error is by adding agriculture and industrial metals into the mix, to reflect the greater importance of food in Asian CPI baskets and the increased focus on construction and infrastructure development in the region."

These additional elements are added to the index through exposure to Deutsche's proprietary food and metals indices. The total weighting of the various components add up to more than 100% to reflect the fact that Asian inflation tends to be higher than inflation in G3 countries.

An index such as this provides a much better hedge than some of the common proxies used in the market, such as commodities. One of the reasons for the high tracking error with such strategies is the fact that inflation tends not to be volatile, whereas returns from commodities are notoriously unstable. The Deutsche index, on the other hand, clocked an annualised volatility of just 1.46%.

Property is another popular hedge because rents typically rise in line with inflation, but Parker says the tracking errors in property have also been horrible.

At the moment the index is only available in an Asia-wide form, but Deutsche says that it has also started to offer specific over-the-counter inflation hedges for some local markets in Asia.