TIPS ETFs: Watch Out if Rates Rise Faster than Inflation

February 28th at 8:58am by John Spence

The largest ETF tracking Treasury Inflation Protected Securities is down about 2% since the end of November, falling along with nominal Treasuries as yields have ticked higher.

During that time, investors have pulled over $1.3 billion from iShares Barclays TIPS Bond Fund (NYSEArca: TIP). The popular ETF still holds more than $21 billion in assets under management.

“Many individual investors purchase TIPS “in the belief that they are as safe as safe can be: The full faith and credit of the U.S. government stands behind them, and their returns adjust to keep up with inflation,” writes Linda Stern at Reuters.com.

“But here’s a fact that some may find surprising. If interest rates move up faster than consumer prices do, their TIPS investments can turn around and bite them,” she points out. “A low-yielding inflation-protected bond could actually lose value faster than a comparable non-inflation protected bond in that scenario.”

With TIPS, the yield is based on changes in the Consumer Price Index as well as Treasury yields. TIPS ETFs “might sound like a great idea on the surface, but they’re a much different animal than holding the bonds themselves,” writes Daniel Putnam at InvestorPlace. ETFs that invest in TIPS with longer durations have risks that might not be apparent because they are sensitive to interest rates, he said. TIP, the iShares ETF, has a weighted average maturity of 9 years.

The concern is that investors bought TIPS as an inflation hedge without considering the rate risks.

“Despite its inflation protection, fluctuating interest rates still lead to volatility here,” according to a Morningstar analyst report on TIP. [TIPS ETFs Hurt by Rising Treasury Yields]

“It is important to note that inflation is just one component of interest rates and that changes in the ‘real rate’ or the risk-free cost of capital will cause the value of TIPS to oscillate up or down just like Treasury bonds,” it said. “Because yields are near all-time lows, even if inflation expectations rise, TIPS bonds are still a low-return investment. Finally, if interest rates rise faster than inflation expectations, then TIPS will still lose value.”

“Anyone who believes TIPS are a safe investment is certainly not doing their homework,” said Jason Ware, market strategist and chief analyst for Albion Financial Group, in the Reuters column. “When rates do rise, which eventually they will, there is going to be some pain in TIPS.”

iShares Barclays TIPS Bond Fund

tips-etf

Full disclosure: Tom Lydon’s clients own TIP.

The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

Tickers