How To Treat TIPS ETFs Right Now

Of the various hot trades within the fixed income universe this year, the influx of new money to Treasury Inflation-Protected Securities, or TIPS, has been particularly noticeable.

This year is something of a perfect storm for TIPS. Inflation is an increasingly important topic for the Federal Reserve, and investors have been pouring billions of dollars into fixed income exchange-traded funds. That theme has benefited ETFs such as the iShares Barclays TIPS Bond Fund (ETF)TIP. However, an often overlooked element to fighting inflation with ETFs like TIP is that some of these funds can have longer durations, introducing interest rate risk to the equation.

A Few Tips On TIPS

“When positioning portfolios for inflation, it's important to remember that trade-offs are always involved. Simply buying TIPS will add duration risk. Selling nominal Treasuries to buy TIPS of equivalent duration can be a useful hedge against inflation. However, simply buying the broad TIPS exposure may still result in a high level of interest rate risk within a portfolio,” said State Street Vice President David Mazza in a recent note.

Another rub for investors with hedging against inflation via ETFs is these funds are not great income generators. For example, the real yield on TIP, the iShares product, is just 0.08 percent, according to issuer data. Real yield is an investment's returns adjusted for inflation.

Managing Risk

Investors looking to manage interest rate risk while still employing the inflation-fighting advantages of TIPS have some options in the world of ETFs, including the SPDR Bloomberg Barclays 0-5 Year TIPS ETF (SPDR Series Trust SIPE).

SIPE, which tracks the Bloomberg Barclays 0-5 Year U.S. Government Inflation-linked Bond Index, has a modified duration of about 2.5 years. That compares with an effective duration of 7.66 years on the aforementioned TIP.

“While shortening the duration of a TIPS exposure results in a lower yield, the chart below shows it still provides an attractive breakeven ratio, or yield received for the amount of risk that an investor takes. Lower duration TIPS funds' headline yield level may be lower, but their portfolio impact may be more beneficial than broad-based TIPS because they require less duration (risk) to earn that yield,” added Mazza.

Another low duration idea among TIPS ETFs is the SPDR Bloomberg Barclays 1-10 Year TIPS ETF (SPDR Series Trust TIPX). TIPX has a modified adjusted duration of 3.4 years. That ETF, which is 3.5 years old, follows the Bloomberg Barclays 1-10 Year Government Inflation-linked Bond Index.