Turning to TIPS ETFs to Protect Portfolios Against Inflation

In an effort to protect portfolios against inflation, investors frequently turn to TIPS, or Treasury Inflation Protected Securities. These specialty Treasury bonds function by carrying an embedded link to the consumer price index published by the Bureau of Labor Statistics. TIPS can see their face value dynamically adjust higher during periods of inflationary headwinds, creating a more attractive rate of return for investors in these debt securities.

As inflation begins to pick up on a growing economy with an 18-year low in unemployment and steadily rising wages, investors may want to think about ways to protect their investments against lower real returns. Consequently, one should consider allocations to assets expected to perform well when inflationary pressures rise.

ETFs that track Treasury inflation protected securities such as the iShares TIPS Bond ETF (NYSEArca: TIP) track 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.

TIP is one of the largest ETFs providing access to TIPS.

“Fed officials have also signaled they may be willing to allow for modest overshoots above the central bank’s inflation target to make up for past undershoots,” said BlackRock in a recent note. “This could lead inflation-protected bonds to outperform their nominal counterparts–underlining our call for adding some exposure to Treasury Inflation-Protected Securities (TIPS) at the expense of nominal bonds.”

Betting On TIP ETF

Changes in inflation expectations can cause increased trading activity as investors adjust to a new break-even rate – the yield difference between nominal Treasury bonds and TIPS of the same maturity, and cause swings in TIP prices.

“We see TIPS (Treasury Inflation-Protected Securities) performing well in our base case of a Fed pause and ongoing, albeit slower global growth,” said BlackRock.

Related: ETF Investors Are Easing Back on Emerging Markets

Investors considering TIPS should monitor Fed language.

“The recent change in the Fed’s commentary around inflation suggests the central bank would likely want to see inflation slightly exceed its target before considering a resumption of policy tightening–for fear of choking off economic growth,” according to BlackRock.

For more information on ETFs, visit our ETF Performance Reports category.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.