TIPS ETFs: Interest Rates and Inflation

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.