Fixed income investors looking for a cost-effective way to protect bond portfolios from the ill effects of inflation can consider exchange traded funds such as the PIMCO 1-5 Year U.S. TIPS ETF (NYSEArca: STPZ).
STPZ tries to reflect the performance of the market-cap-weighted ICE Bank of America Merrill Lynch 1-5 Year U.S. Inflation-Linked Treasury Index, which is comprised of TIPS with between one and five years until maturity. The portfolio shows a 0.20% expense ratio, a 1.88% 30-day SEC yield and a 2.92 year effective duration.
Investors will typically look at TIPS ahead of an inflationary period since buying TIPS after inflation has gone up means that the security has already priced in the inflation and investors would likely be overpaying for the TIPS exposure.
TIPS are a type of Treasury security that is indexed to inflation as a way to shield investors from the negative effects of inflation. The securities’ par value rises with inflation as measured by the Consumer Price Index while interest rate remains fixed. TIPS also offer investors another layer of diversification as many aggregate bond funds exclude TIPS from their holdings.
STPZ’s “duration risk is limited. Since the fund’s index weights its holdings by market capitalization, its duration can change over time,” according to Morningstar. “For example, if the U.S. government issues large quantities of five-year TIPS, the duration of the fund will lengthen and vice versa. However, even if the fund invests 100% of its capital in the five-year TIPS, the duration would be less than five years.”