Investors who bought TIPS ETFs for inflation protection have received a harsh lesson on how they can lose money when Treasury yields rise.
The iShares TIPS Bond ETF (NYSEArca: TIP) is down about 8% for the trailing three months, according to Morningstar.
The TIPS fund has a weighted average maturity of nearly 9 years and has fallen harder than iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF), which is off 6% the past three months.
TIPS are sensitive to interest rates like nominal Treasury bonds, so their prices can fall when yields rise.
“TIPS should hold up relatively well in a rising-rate environment caused by rising inflation because they offer investors principal payments based on the level of inflation in the economy,” according to a note from Morgan Stanley Wealth Management. “However, if there is a spike in rates without an increase in inflation, TIPS could underperform.”
The latter situation is what TIPS investors have endured in recent months. Treasury yields have spiked in the wake of Federal Reserve Chairman Ben Bernanke indicating the central bank may curb its bond purchases if the economy improves.
Meanwhile, inflation remains subdued and investors are scaling back their inflation expectations. [TIPS ETFs Continue Slide]
Next page: TIPS ‘trap’
“Unless inflation goes higher, then all you have with TIPS is interest rate risk, just like every other Treasury,” said noted bond fund manager Jeffrey Gundlach in a recent Bloomberg article. “It’s an asset class that is exposed to investor surprise and disappointment.”
Gundlach has also called TIPS a “disaster” and a “trap,” according to the report.
TIPS ETFs have been slammed by a decline in the so-called breakeven rate between TIPS and Treasuries.
This rate is calculated by comparing yields on TIPS to Treasuries of similar duration. If inflation averages more than the breakeven rate over a given time period, then investors would be better off owning TIPS than normal Treasury bonds.
However, a combination of rising Treasury yields and low inflation has caused a lot of pain for TIPS investors recently.
iShares TIPS Bond ETF
Full disclosure: Tom Lydon’s clients own TIP.