Here’s what individual investors should know about Treasury inflation-protected securities
The largest fund in this sector is the Vanguard Short-Term Inflation-Protected Securities ETF (VTIP). It has had net inflows of approximately $12 billion since January 1, bringing its assets under management to approximately $54 billion.
US economic data is giving warning signs in the coming times. Federal Reserve Board Chairman Jerome Powell as well as several economists and investment strategists say they expect inflation to remain in place through 2022 due to a confluence of factors. These include: supply-chain and labor shortages; Rise in the prices of energy, food and housing; and a boom in consumer demand. In August, the consumer-price index, or CPI—a measure of personal consumption—was up 5.3% compared to the same period last year. This is the highest level of inflation in 13 years.
“Inflows into the TIPS sector are coming from individual investors, financial advisors on behalf of clients, institutional investors, central banks and global pension plans,” says Gemma Wright-Casparius, principal and senior portfolio manager, fixed income at Vanguard.
Because of their inherent protection against inflation, TIPS are recommended by some experts as fixtures in fixed-income portfolios. Todd Rosenbluth, head of ETF and mutual fund research at CFRA, suggests that they could also be a replacement for traditional Treasuries. The principal value of each bond is indexed into the CPI, and therefore grows at the same rate as inflation, although the interest rate payable remains the same.
Here is an example of how TIPS works. If you bought a security with a face value of $1,000 and the CPI increased 1% over the next six months, the value of the bond principal would increase by $10. And since interest payments are based on principal, interest payments will increase as well. At maturity, in addition to the interest payments already received, the holder receives the face value of the bond or the adjusted value of the principal, whichever is higher. TIPS come in five-, 10- and 30-year maturity periods. Like traditional treasuries, they are backed by the US government and pay half-yearly interest.
But tips come with risks. Alice Pfeiffer, managing director of fixed-income research for Raymond James, says that TIPS typically weaken Treasuries, “especially in times of deflation.” Although deflation is rare, if it does happen, as prices fall, the value of the principal will also fall as it moves in line with the index. Therefore, investors take the risk of lower interest payments, and loss of principal if they have to sell before maturity; The loss of principal on maturity is also a risk for investors who have purchased the security at a premium.
Another risk TIPS holders face is that, during periods of inflation, interest rates on traditional Treasuries and other bonds can offer higher returns than TIPS and their fixed coupons. With traditional Treasury buying and selling, “inflation expectations are built into their prices,” says Brian Therian, senior fixed-income analyst at Edward Jones.
When evaluating whether to buy TIPS or traditional US Treasuries, Mr. Therian suggests investors look at a key benchmark: break-even inflation. Emotion Published by the St. Louis Federal Reserve Bank. This rate reflects a market-based measure of expected inflation. For example, the break-even inflation rate for the 10-year Treasury on September 27 was 2.40%. If an investor expects inflation to exceed 2.40% over the next 10 years, the 10-year TIPS is considered a better buy than the standard 10-year US Treasury.
“Also note that until your TIPS mature, you will still have to pay income tax at par on any growth on these investments,” says Mr. Therian. “You can manage this by keeping them in tax-advantaged retirement accounts.”
TIPS holding funds and ETFs focus on different tenors. Some, such as the Schwab US TIPS ETF (SCHP), are passive funds designed for investors with a short-term horizon who bet that inflation will climb. The $20 billion fund tracks the Businesshala Barclays US Treasury Inflation-Linked Bond Index (Series L), and its TIPS have at least one year remaining to maturity and are rated investment grade. Its 12-month yield as on August 31, 2021 is 3.01%. For investors with a longer-term outlook on inflation, there are funds like the $835 million PIMCO 15+ Year US TIPS ETF (LTPZ), which tracks an index of TIPS with maturities of at least 15 years. Its 12-month yield ended August 31, 2021 is 3.08%.
Investors should look at each fund’s expense ratio to determine the return after management fees. Also, says Ms. Wright-Casparius, look at the contents of the fund’s portfolio so you can assess investment risk. In addition to inflation-protected securities, she says, “some funds hold mortgage-backed securities, global inflation-linked bonds, commodities, and broad mandates that change over time.”
Morningstar data indicates the top three inflation-protected bond funds awarded to individual investors in terms of total return as of August 31, 2021. All have invested more than 50% of their portfolio in TIPS. They:
Eaton Vance Short Duration Inflation-Protected Income Fund (EARX) This $360 million open-end fund invests at least 80% of its assets in TIPS with maturities of up to 3.5 years. YTD Return: 5.82%. Expense Ratio: 0.90%. 12-month dividend yield: 2.75%.
Wells Fargo Real Return Fund (ipbjx) The $60 million open-end fund invests 80% in debt securities, of which 65% are TIPS, 20% in equities. YTD Return: 5.46%. Expense Ratio: 0.40%. 12-month dividend yield: 3.68%.
American Century Short Duration Inflation (APOGX) At least 80% of the open-end fund’s $2.8 billion in assets is invested in TIPS. It can invest 20% of its assets in securities dominated in foreign currencies. YTD Return: 5.35%. Expense Ratio: 0.01%. 12-month dividend yield: 1.37%.
According to an analysis by CFRA, these are the top three inflation-protected ETFs that have generated YTD’s highest returns as of September 24.
FlexShares iBoxx 3 Year Target Term TIPS Index Fund (TDTT) This $1.4 billion fund invests 80% in securities that are in the iBoxx 3-Year Target Term TIPS Index. YTD Return: 4.17%. Expense Ratio: 0.18%. 12-month dividend yield: 3.21%.
iShares 0-5 Year TIPS Bond ETF (STIP) The $6.7 billion fund invests in TIPS that have a maturity of less than five years. It typically invests 90% of its assets in the Businesshala Barclays US Treasury Tips 0-5 Index. YTD Return: 4.15%. Expense Ratio: 0.05%. 12-month dividend yield: 3.19%.
PIMCO 1-5 Year US TIPS Index ETF (STPZ) The $1.1 billion fund seeks to provide the total return of the ICE BOA 1-5-year US Inflation-Linked Treasury Index that tracks TIPS with maturities ranging from one to five years. YTD Return: 4.14%. Expense Ratio: 0.20%. 12-month dividend yield: 2.9%.
Ms. Ioannou is a writer in New York. he can be reached here [email protected].