Exchange-traded funds (ETFs) that invest in U.S. Treasury inflation-protected securities (TIPS) present a very convenient way for investors to gain exposure to these government-guaranteed fixed-income instruments.
A quick refresher: TIPS are issued with a fixed interest rate and come with maturities of five, 10 and 30 years. TIPS' principal, or face value, changes with the Consumer Price Index (CPI). Inflation causes the face value of the bonds to rise, while deflation causes it to go down. Since the principal amount fluctuates with the CPI, so does the actual interest paid out (though the interest rate itself remains the same). The principal repaid at maturity is either the adjusted principal or the original one, whichever is greater. Thus, investors are protected against inflation—the traditional enemy of fixed-income instruments—and deflation as well.
Of course, you pay for protection: On an absolute basis, TIP yields are relatively low. That doesn't mean that TIPS can't perform, however. In fact, for all of 2019, TIPS had a total return of 9.1%, better than the 7.6% return on straight Treasurys.
For investors tempted to tip their portfolios into some inflation-protected instruments, here are four of the top ETFs.
All figures are current as of Jan.11, 2020.
- Exchange-traded funds (ETFs) that invest in U.S. Treasury inflation-protected securities (TIPS) offer a convenient, diversified option for income-oriented investors.
- Three of the top ETFs in this sector include iShares TIPS Bond ETF, Vanguard Short-Term Inflation-Protected Securities ETF, and PIMCO 15+ Year U.S. TIPS ETF.
iShares TIPS Bond ETF
The iShares TIPS Bond ETF (TIP) tracks the performance of the Bloomberg Barclays U.S. Treasury Inflation Protected Securities Index, which is composed of TIPS with maturities ranging from one to 20-plus years. Nearly half (48.36%) of the fund's $21 billion worth of holdings is concentrated on securities with maturities from five to seven years or seven to 10 years, and the fund's weighted average maturity is 7.99 years. The 12-month yield stands at 1.75%, and investors can expect to receive a weighted yield to maturity of 1.71%. The fund's effective duration is 7.37y ears, making it somewhat sensitive to the changes in interest rates. Its annual expense ratio is 0.19%.
This ETF is most appropriate for investors who are interested in investing in TIPS with effective durations of about eight years and do not mind their holdings being sensitive to the changes in the interest rate.
Vanguard Short-Term Inflation-Protected Securities ETF
The Vanguard Short-Term Inflation-Protected Securities ETF (VTIP) tracks the performance of the Bloomberg Barclays U.S. 0-5 Year TIPS Index, which is composed of securities that mature in less than five years. With net assets of $32 billion, VTIP holds 17 different bonds with an average coupon rate of 0.4%; over 80% of them have one-to-three year maturities or three-to-five-year maturities. The fund's effective average duration and effective maturity stand at 2.5 years, making it much less sensitive to changes in the benchmark interest rate but much more responsive to changes in CPI. For this reason, VTIP offers strong protection against inflation compared to other ETFs with longer effective duration. VTIP's yield to maturity is 1.5%, and it has an annual expense ratio of 0.06%, which is much lower than the 0.17% expense ratio for similar funds.
VTIP is most appropriate for investors who are concerned about unexpected inflation but at the same time want exposure to TIPS with shorter durations that are less sensitive to changes in interest rates in the U.S.
PIMCO 15+ Year U.S. TIPS ETF
The PIMCO 15+ Year U.S. TIPS ETF ( LTPZ) seeks to obtain investment results that correspond to those of the BofA Merrill Lynch 15+ Year US Inflation-Linked Treasury Index, which is composed of TIPS with maturities of at least 15 years. LTPZ holds a portfolio of $263.3 million in 11 different TIPS maturing between 2035 and 2049, and the fund's effective maturity is 24.5 years, while its effective duration stands at 21.39 years. LTPZ has a yield to maturity of 2.52% and an average coupon rate of 1.5%. The fund's expense ratio is 0.2%. Not only is the fund exposed to inflation rate changes, but it is also highly sensitive to interest rate changes. It demonstrates a five-year standard deviation of 11.5%, which is double that of the TIP and VTIP ETFs.
LTPZ is most suitable for investors who are interested in investing in TIPS with much longer maturity and have a high tolerance for interest rate risks.