When inflation moves higher, fixed income investors often turn to Treasury Inflation-Protected Securities, a corner of the bond market easily accessible via exchange traded funds.
TIPS, which are viewed as a low-risk investment, are indexed to inflation. The par value of TIPS rises with increases in the Consumer Price Index. Interest rates on TIPS are fixed and yields on these bonds and the related ETFs are usually low relative to other fixed income assets.
Recent data from the Commerce Department indicates U.S. consumer prices are inching higher, meaning it could be time for investors to consider ETFs such as the PIMCO 1-5 Year U.S. TIPS Index Exchange-Traded Fund (NYSE: STPZ). STPZ, which is over eight years old, follows the BofA Merrill Lynch 1-5 Year US Inflation-Linked Treasury Index.
STPZ has a duration of just over three years and the effective maturity of the ETF's 12 holdings is just 2.94 years.
“The short maturity-focused mandate gives the portfolio a duration of 3.1 years (as of November 2017), which mitigates interest rate risk and provides a strong hedge against immediate inflation,” said Morningstar in a recent note. “Gains and losses from price volatility are muted thanks to the strategy's short duration. As a result, this fund more closely tracks the realized inflation fluctuations over the short run than its longer duration counterparts do.”
The $1-billion STPZ has a 30-day SEC yield of 1.64 percent. The Federal Reserve's gauge of inflation rose 0.2 percent in November and 1.8 percent year-over-year. The Fed is targeting inflation of 2 percent, a mark that has been missed for several years.
How STPZ Benefits
Obviously, rising inflation benefits a fund such as STPZ, but investors need to understand how those benefits are realized.
“Break-even inflation is the rate that would equate the real return from regular U.S. Treasuries and TIPS with the same maturity,” according to Morningstar. At the end of November 2017, the break-even inflation rate was 1.8 percent, which was 0.2 percent lower than the 10-year rolling break-even rate average of 2 percent. If actual inflation exceeds 1.8 percent, it would reward TIPS investors, but if it is lower than this threshold, U.S. Treasury bonds would come out ahead.”
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