One of the largest ETFs tracking inflation-protected bonds invests in foreign debt rather than so-called TIPS sold by the U.S. Treasury.
“WIP bonds’ principal is linked to changes in the various local inflation-tracking benchmarks of the sponsoring foreign governments, and it provides an effective hedge against inflation in an investor’s portfolio relative to standard international government bonds,” writes Morningstar analyst Timothy Strauts in a report.
Many governments around the world issue securities designed to provide inflation protection to investors. WIP has a yield to maturity of about 1%.
“As the inflation indexes rise, the principal in the individual bonds is adjusted upward. The coupon on the bond is then paid on the higher principal, which raises the overall effective yield of the security,” explains Morningstar’s Strauts. “The inflation adjustment does swing both ways, though, so any decrease in prices will result in a decrease of WIP bonds’ principal.”
Some European Central Bank employees want inflation protection for their pensions, according to recent reports.
U.S. investors who use WIP also get exposure to foreign currencies. For example, top country holdings as of March 31 were the U.K. at 19.4% and France at 16.8%, according to sponsor State Street Global Advisors.
The largest ETF in the category is iShares Barclays TIPS Bond Fund (NYSEArca: TIP - News) . It holds $22.4 billion in assets and invests in U.S. Treasury Inflation-Protected Securities. TIP has an average yield to maturity of 1.6%, according to manager BlackRock.
The inflation “break-even rate” is important to watch. It is determined by comparing the yields of regulator government bonds against inflation-protected securities of the same duration, usually 10 years. If inflation averages more than the breakeven rate over the next decade, then investors would be better off owning TIPS than normal Treasury bonds. [Why TIPS ETFs Have Negative Yields]
PIMCO Total Return ETF (NYSEArca: BOND - News) manager Bill Gross on Friday tweeted that investors should consider TIPS for cheap inflation protection. The firm also oversees the ETF PIMCO 1-5 Year U.S. TIPS Index Fund (NYSEArca: STPZ - News).
Earlier this year, the U.S. Treasury auctioned TIPS at negative yields. Investors bought the bonds as an inflation hedge. [TIPS ETFs and Negative Yields]
SPDR DB International Government Inflation-Protected Bond ETF