Fixed income investors looking to guard against inflation often turn to Treasury inflation-protected securities, or TIPS, an asset class well-represented in the world of ETFs.
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.
ETF investors can gain exposure to Treasury inflation protected securities through a number of options, including the iShares TIPS Bond ETF (NYSEArca: TIP), Schwab U.S. TIPS (NYSEArca: SCHP) and SPDR Barclays TIPS ETF (NYSEArca: IPE). TIP was one of the top ETFs last year in terms of new assets added.
One of the cheapest options among TIPS ETFs is the Vanguard Short-Term Inflation-Protected Securities ETF (NYSEArca: VTIP). VTIP charges just 0.07% per year, or $7 on a $10,000 investment. That makes it cheaper than 90% of competing funds.
VTIP “provides protection against inflation, credit, and interest-rate risk because it only invests in TIPS shorter than five years and is backed by the full faith and credit of the U.S. government,” said Morningstar in a recent note. “The fund’s duration of 2.7 years as of September 2017 was shorter than the average duration of 5.7 years for the inflation-protected bond Morningstar Category that encompasses the broad TIPS market. To illustrate, if the rate curve shifts by 1 percentage point, this fund would lose approximately 2.7% of its value, while the average TIPS fund would decline by 5.7%.”
Related: Using ETFs to Manage Inflation Risks
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.
“TIPS aren’t always a better bet than non-inflation-protected Treasuries. The current U.S. Treasury yield reflects the market’s expectation for the future inflation. If realized inflation is less than the expectation, Treasuries would offer better real returns than TIPS,” according to Morningstar.
VTIP holds 15 bonds with an average duration of 2.8 years. Duration measures a bond’s sensitivity to changes in interest rates. VTIP has yield to maturity of 1.5%.
For more information on Treasury inflation protected securities, visit our TIPS category.