Do TIPS ETFs Deserve A Look As Inflation Rises?

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Includes: IPE, LTPZ, TIPZ
by: Zacks Funds

Inflation has been floppy for most developed economies, including the U.S., for quite some time now. Reaching 2% inflation - as targeted by most of the central banks - has become a tall order, with both the eurozone and Japan struggling to ward off deflation. The nagging oil price crisis over the last one and a half years seems to be the main culprit.

While the ECB and Bank of Japan were compelled to pursue QE measures to fight deflationary threats. Back home, subdued inflation checked the Fed from being aggressive on the policy tightening issue. Even after the lift-off in December, market watchers were under the impression that the Fed will likely apply a single hike, at the most, this year, thanks to the global market upheaval and subdued inflation.

In such a scenario, the U.S. inflation rate rose 1.4% for the fourth successive month in January - the best annual gain last seen in October 2014, and surpassing market expectations of a 1.3% gain. Core consumer price index (CPI) jumped to 2.2% in January. The reading was the highest since June 2012, and it came above the goal set by the Fed at 2%.

Higher rents, healthcare and transportation costs boosted inflation in January. Excluding food and energy, consumer prices rose 0.3% in January - a four and-a half year high, and higher than the last month's increase of 0.2%.

Time for TIPS ETFs?

TIPS offers robust real returns during inflationary periods, unlike its unprotected peers in the fixed-income world. These securities pay an interest on an inflated principal amount (principal rises with inflation), and when the securities mature, investors get either the inflation-adjusted principal or the original principal, whichever is greater. As a result, both principal amount and interest payments will keep on rising with increasing consumer prices.

This mechanism makes TIPS ETFs investors' darlings in times of rising inflation. Presently, the iShares TIPS Bond ETF (NYSEARCA:TIP) is one of the biggest beneficiaries of this trend, having hauled in $256.5 million last week. The fund is up 1.5% this year (as of February 19, 2016).

Is the Bet Worth It?

Though the decline in oil prices has slowed, things are yet to stabilize in the oil patch. So, it is too early to take a call on the inflation picture. Of course, the recent trend is pointing toward solid inflation, and the upbeat January data has made the case stronger for faster Fed tightening.

However, a lot of the future trend of inflation depends on the movement of energy prices. Still, investors with a long-term view can count on the potential uptick in inflation, as the U.S. economic backdrop remains more or less ,steady and issues in the energy space should be sorted sooner or later. With the economy and the job market mending, inflation will definitely increase in coming months. Below, we highlight a few outperforming TIPS ETFs which could be compelling investments if U.S. inflation continues to rise (see all TIPS ETFs here).

PIMCO 15+ Year U.S. TIPS Index ETF (NYSEARCA:LTPZ)

This fund targets long-term securities of the TIPS market by tracking the BofA Merrill Lynch 15+ Year US Inflation-Linked Treasury Index. In total, the product holds 7 bonds having effective maturity of 26.41 years and carrying a high interest rate risk, given the effective duration of 21.83 years.

In terms of credit quality, the fund boasts top-rated bonds from Moody's and the S&P, suggesting lower default risk. The ETF is less popular and less liquid, with AUM of $98.1 million. LTPZ has generated excellent returns of about 3% so far this year (as of February 19, 2016).

SPDR Barclays Capital TIPS ETF (NYSEARCA:IPE)

This fund targets long-term securities of the TIPS market by tracking the Barclays Capital U.S. Government Inflation-Linked Bond Index. In total, the product holds 37 bonds having effective maturity of 9.08 years and carrying a moderate interest rate risk, given the effective duration of 4.90 years.

In terms of credit quality, the fund boasts top-rated bonds. The ETF is moderately popular and less liquid, with AUM of $637.5 million. IPE has gained about 1.6% so far this year (as of February 19, 2016).

PIMCO Broad U.S. TIPS ETF (NYSEARCA:TIPZ)

This $66.4 million fund looks to track the BofA Merrill Lynch US inflation-linked Treasury index. The fund holds 19 securities and has an effective maturity of 9.09 years, while its effective duration is 8.26 years. It charges 55 bps in fees, and is up 1.8% so far this year (as of February 19, 2016).

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