ETFs that hold Treasury Inflation-Protected Securities have been popular with investors seeking an inflation hedge because the bonds’ principal is linked to changes in the Consumer Price Index.
However, it’s very important to remember that since the ETFs invest in Treasury bonds, they can be hurt by rising interest rates.
“TIPS will not perform well if real yields rise along with rising interest rates,” said Russ Koesterich, iShares chief investment strategist.
“Despite its inflation protection, fluctuating interest rates still lead to volatility here,” Morningstar adds in an analyst report on iShares Barclays TIPS Bond Fund (NYSEArca: TIP).
Other ETFs for this asset class include PIMCO 1-5 Year TIPS (NYSEArca: STPZ), SPDR Barclays Capital TIPS (NYSEArca: IPE) and Schwab U.S. TIPS (NYSEArca: SCHP).
Koesterich said TIPS are his favorite inflation fighters, trailed by commodities, cash, equities, real estate. Nominal bonds are at the bottom of the ladder because inflation kills the purchasing power of fixed-income securities.
The strong demand for TIPS is evidenced by the fact that investors are buying the securities even though the bonds have negative yields. [TIPS ETFs and Negative Yields]
Although the iShares strategist sees inflation as a “significant risk for investors in 2013 and beyond,” he doesn’t expect a sharp spike in inflation this year.