How To Use TIPS Funds To Hedge Against Inflation

From Zacks: The United States has been striving to reach its 2% inflation target. The Federal Reserve raised interest rates by a quarter percentage point for the first time since 2006 in December 2015. This step was taken after keeping interest rates at near zero levels since the 2008-09 crisis.

The Federal Reserve further raised the target federal funds rate by a quarter percentage point in December 2016 and another quarter percentage point to 0.75%-1% in the March 2017 FOMC meet. These steps have taken the economy closer to its goal. The U.S. Consumer Price Index rose 2.7% year over year in February. However, it just rose 0.1% month on month.

However, Fed’s preferred measure of inflation, the Personal-Consumption Expenditures price index (PCE) edged up 2.1% year over year. This was the strongest gain for the index measure in five years. However, excluding food and energy, the core PCE is still below the target at 1.8% (read: 4 Stocks to Beat the Fastest Rise in Inflation in 5 Years).

Plunging oil prices made it difficult for most of the major economies to reach their target inflation rate. Then, the OPEC production cut deal in November helped in pushing up inflation. Although oil prices trended down in February due to increased U.S. shale, news of further cuts can lead to a recovery in prices (read: Can Oil ETFs Rebound on Possibility of More OPEC Cuts?).

A moderate rate of inflation is good for the economy. It signals that activity is growing and the risks have diminished. The Consumer Confidence index rose to a 16-year high in March 2017 to 125.6. These factors could give leeway to the Federal Reserve to further hike rates this year.

The Fed expects to reach its target inflation this year. This is the time when TIPS investing come into the spotlight as investors bet on these inflation protected bond ETFs. We will therefore focus on the following short-term TIPS ETFs.

FlexShares iBoxx 3-Year Target Duration TIPS Index Fund (TDTTFree Report)

This fund seeks to track the iBoxx 3-Year Target Duration TIPS Index.

The fund has AUM of $2.01 billion and charges a paltry 20 basis points in fees per year. It has a Weighted Average Duration of 3.01 and Weighted Average Maturity of 3. The fund returned 0.57% in the past one year and in the year-to-date time frame (as of April 3, 2017).

Vanguard Short-Term Inflation-Protected Securities ETF (VTIPFree Report)

This fund seeks to track the Barclays Capital U.S. Treasury Inflation-Protected Securities (TIPS) 0-5 Years Index.

The fund has AUM of $3.2 billion and charges a paltry 10 basis points in fees per year. It has a Weighted Average Duration of 2.55 and Weighted Average Maturity of 2.60. The fund returned 1.06% in the past one year and 0.81% in the year-to-date time frame (as of April 3, 2017).

SPDR Barclays 0-5 Year TIPS ETF (SIPEFree Report)

This fund seeks to track the Barclays Capital 0-5 Year U.S. TIPS Index.

The fund has AUM of $3.2 billion and charges a paltry 10 basis points in fees per year. It has a Weighted Average Maturity of 2.60. The fund returned 1.17% in the past one year and 0.30% in the year-to-date time frame (as of April 3, 2017).

iShares 0-5 Year TIPS Bond ETF (STIPFree Report)

This fund seeks to track the Barclays Capital U.S. Treasury Inflation-Protected Securities (TIPS) 0-5 Years Index.

The fund has AUM of $1.22 billion and charges a paltry 10 basis points in fees per year. It has a Weighted Average Duration of 2.55 and Weighted Average Maturity of 2.60. The fund returned 0.92% in the past one year and 0.72% in the year-to-date time frame (as of April 3, 2017).

PIMCO 1-5 Year U.S. TIPS Index Exchange-Traded Fund (STPZFree Report)

This fund seeks to track the BofA Merrill Lynch 1-5 Year US Inflation-Linked Treasury Index.

The fund has AUM of $1.14 billion and charges a paltry 20 basis points in fees per year. It has a Weighted Average Maturity of 3. The fund returned 0.82% in the past one year and 0.50% in the year-to-date time frame (as of April 3, 2017).

To Conclude

TIPS ETFs are attractive investments in times of higher expected inflation as the par value adjusts with inflation, as measured by CPI, while the interest rate remains fixed. Therefore, the interest is computed at a higher par value with the increase in CPI noted. In the current scenario, with inflation expected to rise further, we believe it is prudent to hedge against it with TIPS investment.

The iShares Barclays TIPS Bond Fund ETF (NYSE:TIP) was unchanged in premarket trading Wednesday. Year-to-date, TIP has gained 1.30%, versus a 5.35% rise in the benchmark S&P 500 index during the same period.

TIP currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #1 of 13 ETFs in the Inflation-Protected Bond ETFs category.


This article is brought to you courtesy of Zacks Research.

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