ETFs following inflation-indexed bonds have run into a buzzsaw this year due to low inflation expectations combined with a move higher in U.S. interest rates.
The iShares TIPS Bond Fund (NYSEArca: TIP) is down nearly 5% the past three months. The ETF invests in Treasury Inflation Protected Securities.
“TIPS–and especially TIPS fundholders–have encountered a perfect storm. With inflation tame, in large part because of slowing growth in emerging markets such as China, demand for the guaranteed inflation protection that TIPS provide is lukewarm,” writes Christine Benz, Morningstar director of personal finance.
“Moreover, TIPS, like nearly every other bond type, tend to be less attractive when interest rates are rising, as they have been recently amid concerns that the Federal Reserve would scale back its bond-buying program,” she said. [TIPS ETFs Show Inflation Worries Not Driving Interest-Rate Spike]
The value of TIPS is indexed to the Consumer Price Index. However, TIPS are sensitive to interest rates like nominal Treasury bonds, so their prices can fall when yields rise. [Rising Rates and Low Inflation a Toxic Mix For TIPS ETFs]
Therefore, the worst possible market for TIPS is when interest rates are rising faster than inflation.
Yet one positive factor for TIPS is that they have been good diversifiers for stocks during their relatively short lifespan, Benz notes.
iShares TIPS Bond Fund
Full disclosure: Tom Lydon’s clients own TIP.