By Eric Dutram
Thanks to the murky economic outlook, the Federal Reserve looks likely to both keep rates extraordinarily low and refrain from more bond purchases at this time. However, if the economy continues to recover and rates remain low, some fear that inflation could begin to pick up and go higher than the Fed’s comfort zone. Meanwhile, others are worried that a slumping economy will push down the rate of inflation and make longer-dated securities more attractive in comparison. Either way, some investors are growing increasingly concerned that the rate of inflation will change significantly in the near term, putting pressure on a number of key portfolio components.
For investors concerned about this, ProShares' recent leveraged ETF launch may be of some interest. In the release, the company revealed two new funds which look to target, for a single day, triple long and triple short exposure to the Dow Jones Credit Suisse 10-Year Inflation Breakeven Index. The two products, the 3x long UltraPro 10 Year TIPS/TSY Spread Fund (UINF) and the triple short UltraPro Short 10 Year TIPS/TSY Fund (SINF), look to play opposite sides of the benchmark. In the index, a long position is taken in the most recently issued 10-year Treasury Inflation Protected Securities (TIPS) bond and duration-adjusted short positions are obtained in U.S. Treasury bonds of the closest maturity. The difference in yield between these bonds is commonly referred to as a "breakeven rate of inflation" and is considered to be a measure of the market's expectations for inflation over a specified period of time (read Can You Fight Inflation With This Real Return ETF?).
So, for investors who believe that the rate of inflation is going to increase and the Fed is behind the curve, UINF could be an interesting pick. Yet for those on the other side of the issue, believing that deflation is more likely to strike than inflation, SINF could be an intriguing choice. However, it is also important to remember that the level of the index fluctuates based on the bonds and that this will not be the same on a percentage basis as changes in the breakeven inflation rate. Furthermore, due to the 3x leverage factor and the daily rebalancing, long-term performances are likely to deviate from what many investors might expect out of the funds (see Understanding Leveraged ETFs).
Inflation Spread Lineup
While it remains to be seen if these new products can capture investor assets, investors should note that for those looking for a similar but unleveraged play, two options are currently available, also from ProShares. The two products, the 30 Year TIPS/TSY Spread Fund (RINF) and the -1x version FINF, seek to apply a similar strategy to longer-dated bonds. Investors should note that while these products may not be leveraged, they are likely to move more on a daily basis than similar, short-duration funds, due to the higher risks involved with 30 year securities. As a result, RINF and FINF may be more appropriate for longer-term investors as well as those looking to buy and hold but play on possible inflation trends. Meanwhile, the newly launched UINF and SINF could be better choices for traders as well as those expecting big moves in a short period of time in the breakeven rate of inflation (read Do You Need A Floating Rate Bond ETF?).