Consumer prices are slowly rising, and the markets are likely underestimating inflation expectations. Consequently, fixed-income exchange traded fund investors may want to consider Treasury bond inflation-protected securities to diversify against inflation ahead.
“Today’s inflation expectations are most likely too low,” according to Russ Koesterich, Global Chief Investment Strategist and Head of Model Portfolio & Solution Business at BlackRock. “Even in a world of slow growth, weak productivity and diminishing labor market slack, inflation may be higher than today’s diminished expectations suggest. Under this scenario, Treasury Inflation Protected Securities (TIPS) may represent a good long-term opportunity.”
U.S. core inflation, which excludes more volatile oil and food prices, increased 0.3% in January, the largest monthly gain since August 2011, after a 0.2% rise in December, according to Reuters. Core CPI also ran 2.2% in January year-over-year, the largest gain since June 2012 and exceeded the 1.0% average annualized increase for the past 10 years.
While higher inflation levels allow the Federal Reserve to implement a tighter monetary policy to reign in rising prices, any hikes would be a more hawkish stance than the market is currently discounting, Kosterich added.
Meanwhile, investors with a more long-term horizon can take a look at a number of TIPS-related ETFs to gain exposure to Treasury inflation-protected securities in anticipation of rising prices ahead. For instance, the iShares TIPS Bond ETF (NYSEArca: TIP) tracks a group of U.S. TIPS from the Barclays U.S. Treasury Inflation Protected Securities Index (Series-L). The ETF comes with an effective duration of 7.62 years and a 0.20% expense ratio.
The SPDR Barclays TIPS ETF (NYSEArca: IPE), which tracks the Barclays U.S. Government Inflation-Linked Bond Index, is a slightly cheaper alternative, with a 0.15% expense ratio and a lower 4.87 year duration. However, IPHE is less actively traded, showing an average daily volume of about 35,000 shares, according to Morningstar.
The Schwab U.S. TIPS (NYSEArca: SCHP), which also tracks the same index as TIP, is the cheapest option in the category, with a 0.07% expense ratio, and comes with a 7.7 year effective duration.
TIPS returns are affected by interest-rate risk like other debt securities, but the inflation-protection aspect allows TIPS to fluctuate their principal value when the Consumer Price Index is adjusted.
Investors are advised to buy into TIPS before inflation has hit to capitalize on rising consumer prices.
“Buying TIPS after inflation has gone up means it has already been priced in and investors are possibly overpaying for their TIPS exposure,” according to Morningstar analyst Brian Moriarty.
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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.