Fixed-income exchange traded fund investors have largely been worried about a rising rate environment as the Federal Reserve plans rate hikes later this year. However, people should not neglect the negative effects of higher inflation.
“One of the greatest risk to retirees’ portfolios is inflation,” Marie Dzanis, Head of Distribution for FlexShares and Northern Trust, told ETF Trends in a call.
Inflationary pressure is rising. The Federal Reserve said that inflation grew slightly across most of the U.S. from April to mid-May as the improved employment situation has contributed to higher labor costs, Reuters reports.
“Tight labor markets were widely noted in most districts,” the Fed said, referring to the U.S. central bank’s 12 regional branches. “Price pressure grew slightly in most districts.”
The tighter labor market has also fueled higher wages for entry-level and lower-skill positions in the South while companies also revealed wage pressures for higher skilled employees in the West and parts of the Midwest. The improving wage growth is seen as a harbinger of faster inflation rates ahead.
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The rising inflation rates will weigh on fixed-income investors’ real interest rate generation, or interest rates after adjusting to remove the negative effects of inflation to reflect the real cost of funds to the borrower and the real yield to the lender.
Additionally, bond investors will have to contend with duration risks as a rising interest rate environment, which will make older issued debt securities less attractive compared to newer issues that offer a higher yield.
Consequently, bond investors may consider TIPS-related ETFs as an inflation hedge.
“TIPS make sense in strategic, buy-and-hold portfolios to hedge against inflation,” Dzanis added.
Moreover, people can manage duration risks by moving down the yield curve to lower-duration TIPS options. For example, bond investors can look to options like the FlexShares iBoxx 5-Year Target Duration TIPS Index Fund Profile (TDTF) and FlexShares iBoxx 3-Year Target Duration TIPS Index Fund (TDTT) .
TDTF tracks inflation-hedging TIPS and seeks to provide targeted duration exposure through changing interest rate and economic cycles. Specifically, the fund includes a target average duration of approximately five years and specific maturity dates of at least three years but not more than 20 years. The ETF shows a 0.56% 30-day SEC yield and a 5.25 year adjusted duration.
TDTT also provides exposure to inflation-hedging TIPs but targets averaged duration of about three years, with maturity dates of at least one year but not more than ten years. The fund has a 0.13% 30-day SEC yield and a 2.80 year duration.
For more information on Treasury Inflation Protected Securities, visit our TIPS category.