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Inflation Zooms to 13-Year High: 5 Solid TIPS ETF Picks

·6 min read

Inflationary pressure in the United States is heating up with consumer price inflation increasing at the fastest pace in more than a decade. This is especially true as the consumer price index (CPI) jumped 4.2% in April from the year-ago level to the highest level in 13-years and rose 0.8% from the prior month, as per data from the Bureau of Labor Statistics.

The so-called core inflation, which strips out volatile components such as food and energy prices, rose 0.9% in April — the largest monthly increase since 1982 — and 3% from the year-ago month (read: Inflation Is Picking Up: 5 ETFs to Make the Most of It).

Behind the Numbers

The surge was driven by higher prices of commodities as well as higher food to transport costs. Prices of used vehicles saw the biggest jump of 10% — the largest monthly increase since these records began in 1953. New vehicles price rose 0.5% while transportation services costs increased 2.9%. Commodity prices, excluding food and energy, rose 2% as cost of raw materials increased to manufacturers while food price grew 0.4%. Meanwhile, shortage of raw materials has boosted prices of everything from lumber to toilet paper.

The trend is likely to continue in the coming months given the huge infrastructure and stimulus packages, widening reach of vaccinations and a healing job market that have led to speedy recovery. In fact, the economy grew 6.4% annually in the first quarter, representing the second-strongest increase since 2003 and is expected to top 7% this year, which would be the fastest since 1984, per several economists. This would follow the worst performance in 74 years when the economy contracted 3.5% in 2020.

According to the IMF, the United States is expected to become the engine of the global economy this year with the strongest growth of 6.4% in decades. The red-hot economy will continue to push inflation higher (read: 5 Top-Ranked ETFs to Ride on a Booming Economy).

Notably, the breakeven rate on five-year U.S. Treasury Inflation-Protected Securities (TIPS) reached the highest since 2006 at 2.71%, ahead of the Fed's 2% inflation target. The five-year breakeven inflation rate — which measures expectations of inflation five years out — reached its highest since April 2011 on May 10 while the 10-year breakeven inflation rate — a measure of expectations of inflation in 10 years time — rose to its highest since March 2013.

How to Tap?

Amid the inflationary backdrop, investing in TIPS ETFs, which offer shelter against rising inflation would be prudent. It not only combats increasing prices but also protects income for the long term.

To explain in details, consider a fixed interest rate of 2.0% on five-year TIPS with an initial face value of $1,000. In the first six months when inflation is zero, the semi-annual interest payment would be $10 but when inflation rises 5% annually in the next six months, the semi-annual interest rate would be $10.25 (1,025*2%-1/2 = 10.25).

This is because TIPS pays interest on an inflated-principal amount (principal rises with inflation) and in this case principal becomes $1,025 when the semi-annual inflation is accounted for. As a result, both principal amount and interest payments will go on rising with increasing consumer prices (see: all the Inflation-Protected Bond ETFs here).

While there are several options in the space to tap rising consumer prices, we have highlighted the five most-popular ETFs that could be compelling investments:

iShares TIPS Bond ETF TIP

This ETF is the most-popular choice in the TIPS space with AUM of $27.8 billion and an average daily volume of 2.4 million shares. It tracks the Bloomberg Barclays U.S. Treasury Inflation Protected Securities (TIPS) Index (Series-L), holding 54 securities in its basket. The fund has an effective duration of 7.49 years and an average maturity of 7.99 years. It charges 19 bps in fees per year.

Schwab U.S. TIPS ETF SCHP

This fund tracks the Bloomberg Barclays US Treasury Inflation-Linked Bond Index (Series-L), holding 50 securities in its basket. It has effective duration of 7.40 years and an average maturity of 7.90 years. SCHP is among the cheapest option in the TIPS space, charging just 5 bps in annual fees. It has AUM to $17 billion and trades in a solid volume of 2.2 million shares a day.

Vanguard Short-Term Inflation-Protected Securities ETF VTIP

With AUM of $13.5 billion, this ETF offers exposure to TIPS that have remaining maturity of less than five years by tracking the Bloomberg Barclays U.S. TIPS 0-5 Year Index. Holding 19 securities in its basket, it has an average duration of 2.6 years and an average maturity of 2.7 years. The product trades in an average daily volume of 1.8 million shares and charges 5 bps in annual fees (read: ETF Strategies to Win From Likely Rise in Inflation).

iShares 0-5 Year TIPS Bond ETF STIP

This fund offers exposure to short-term TIPS with effective duration of 2.69 years and an average maturity of 2.70 years. It holds 19 securities in its basket and follows the Bloomberg Barclays U.S. TIPS 0-5 Years Index (Series-L). STIP has amassed $4.9 billion in its asset base and has 0.05% in expense ratio. It trades in an average daily volume of 457,000 shares.

Quadratic Interest Rate Volatility and Inflation Hedge ETF IVOL

It is a first-of-its-kind fixed income ETF that seeks to profit from relative interest rate movements through Fed rate cuts or rising long-term interest rates. The fund seeks to profit from market stress when fixed income volatility increases while providing the potential for enhanced, inflation-protected income. IVOL has AUM of $3 billion and charges 99 bps in annual fees. It trades in 1.4 million shares a day on average.

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ISHARS-TIPS BD (TIP): ETF Research Reports
 
ISHARS-0-5YTIPS (STIP): ETF Research Reports
 
VANGD-ST TIPS (VTIP): ETF Research Reports
 
SCHWAB-US TIPS (SCHP): ETF Research Reports
 
QUAD-IR V&I HG (IVOL): ETF Research Reports
 
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