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TIPS ETFs Worth Buying as Inflation Rises? - ETF News And Commentary

Zacks Equity Research

Most of the world’s developed nations have been striving hard to log 2% inflation with the Euro zone being busy warding off deflation. A prolonged plunge in oil prices over the last 10 months worsened the situation further.

While it spurred the ECB and Bank of Japan to pursue QE measures in the concerned areas, back home it held the Fed back from hiking key rates even after six long years. However, spring sprung good news for U.S. inflation which grew for two successive months after being beaten down in the snow-capped winter season. 

U.S. consumer prices increased 0.2% sequentially in March mainly buoyed by the energy and shelter indexes which compensated for a drop in the food index. The figure equaled the last month’s rise, which was at an eight-month high. The recent uptrend in oil prices thanks to an easing supply glut led to the upward journey of U.S. inflation. Notably, spot price of WTI crude added around 20% gains (as of April 21, 2015) since it hit this year’s low in March (read: 3 Energy ETFs Leading The Oil Rally).  

Party Time for TIPS ETFs

TIPS offer robust real returns during inflationary periods, unlike its unprotected peers in the fixed-income world. These securities pay an interest on an inflated-principal amount (principal rises with inflation) and when the securities mature, investors get either the inflation-adjusted principal or the original principal, whichever is greater. As a result, both principal amount and interest payments will keep on rising with increasing consumer prices (read: Forget Inflation Fears with These TIPS ETFs).

This mechanism has made TIPS ETFs investors’ darlings in recent time as they are increasingly wagering on these inflation-protected bond ETFs. iShares TIPS Bond ETF (TIP) was one of the biggest beneficiaries of this trend, having hauled in $634 million last week representing its ‘biggest weekly inflow’ since its inception in 2003. The fund is up 2.5% this year (as of April 21, 2015).

Is the Bet Worth?

Investors should note that the headline inflation is still 0.1% lower on an annual basis on account of an 18.3% drop in the energy index. So, the expected trend of inflation depends a lot on the movement of energy prices. Though oil prices are finally starting to see good days, the latest uptrend is barely a few weeks old and is too short a timeframe to understand whether the bull will continue to chase the energy space or slip again?

Moreover, the food index fell 0.2% sequentially in March, with the food at home indicator registering the biggest drop since April 2009. Bloomberg has also indicated Wall Street’s bearish view on the near-term inflation issue. Per those analysts, ‘consumer prices will increase by 2.2% in 2016, after a 0.2% rise this year’ (read: Bleak Global Inflation Backdrop: Sell TIPS ETFs?).

Still, investors with a long-term view can count on the potential uptick in inflation as the U.S. economic backdrop remains robust and things in the energy space should improve sooner or later. With the economy and the job market mending, inflation will definitely increase in the coming months. Below we highlight a few outperforming TIPS ETFs which could be compelling investments if the U.S. inflation continues to rise (see: all TIPS ETFs here):

PIMCO 15 Year US TIPS Index Fund (LTPZ)

This fund targets long-term securities of the TIPS market by tracking the BofA Merrill Lynch 15+ Year US Inflation-Linked Treasury Index. In total, the product holds 7 bonds having effective maturity of 26.30 years and carrying a high interest rate risk given the effective duration of 15.79 years.

In terms of credit quality, the fund boasts top-rated bonds from Moody’s and the S&P, suggesting lower default risk. The ETF is less popular and less liquid with AUM of $103 million. LTPZ has generated excellent returns of over 3% so far this year (as of April 21, 2015).

SPDR Barclays 1-10 Year TIPS ETF (TIPX)

This fund provides long-term exposure to the TIPS market with effective maturity of 5.50 years. This is easily done by tracking the Barclays Capital 1-10 Year U.S. TIPS Index. The ETF has amassed $17.6 million in its asset base and charges a low annual fee of 15 bps.
Holding 24 securities in its basket, the ETF zeroes in on the top-rated securities and has a moderate interest rate risk with effective duration of 5.39 years. The fund is up over 2.8% so far this year (as of April 21, 2015).

FlexShares iBoxx 5-Year Target Duration TIPS Index Fund (TDTF)

This ETF seeks exposure to the mid-term maturity of the TIPS market, holding 12 bonds in its portfolio. It follows the iBoxx 5-Year Target Duration TIPS Index and has accumulated $437.1 million in its asset base. Expense ratio came in at 0.20%.

Average maturity of the fund is 5.46 years while modified duration is 5.20 years. The ETF focuses on higher quality TIPS. TDTF has returned 2.7% in the year-to-date timeframe (as of April 21, 2015).

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