Rising Rates and Low Inflation a Toxic Mix For TIPS ETFs

ETF Trends

Investors who bought TIPS ETFs for inflation protection have received a harsh lesson on how they can lose money when Treasury yields rise.

The iShares TIPS Bond ETF (TIP) is down about 8% for the trailing three months, according to Morningstar.

The TIPS fund has a weighted average maturity of nearly 9 years and has fallen harder than iShares 7-10 Year Treasury Bond ETF (IEF), which is off 6% the past three months.

TIPS are sensitive to interest rates like nominal Treasury bonds, so their prices can fall when yields rise.

“TIPS should hold up relatively well in a rising-rate environment caused by rising inflation because they offer investors principal payments based on the level of inflation in the economy,” according to a note from Morgan Stanley Wealth Management. “However, if there is a spike in rates without an increase in inflation, TIPS could underperform.”

The latter situation is what TIPS investors have endured in recent months. Treasury yields have spiked in the wake of Federal Reserve Chairman Ben Bernanke indicating the central bank may curb its bond purchases if the economy improves.

Meanwhile, inflation remains subdued and investors are scaling back their inflation expectations. [TIPS ETFs Continue Slide]

Next page: TIPS ‘trap’

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