First Global TIPS ETF Hits U.S.

Mar.19.08 | About: SPDR DB (WIP)

By Murray Coleman

The first U.S.-based global international Treasury Inflation-Protected Securities exchange-traded fund launched on Wednesday, opening exposure for investors to TIPS in 18 different countries and 15 different currencies.

The SPDR DB International Government Inflation-Protected Bond ETF (AMEX:WIP) includes TIPS issued in developed foreign markets. But about 30% of its portfolio also comes from emerging markets.

"Inflation is even more of an issue in many emerging markets than most developed countries," said Roger Nusbaum, a portfolio manager at Your Source Financial in Phoenix, Ariz. "And even developed markets like Australia face inflation issues."

Fast-growiing emerging markets such as Turkey and commodities based markets such as South Africa and Brazil in particular are battling inflation, he added. All are included in WIP's portfolio.

Another global TIPS ETF launched last year, the db trackers II iBoxx Global Inflation-Linked Total Return Index Hedged ETF (LUX: DE). But the Deutsche Bank ETF is only offered in Europe and includes exposure to U.S. issues.

WIP has 47 different holdings with mostly A-rated and above credit quality. The average life of those bonds are listed at 9.06 years, although a portfolio duration total wont' be known until the ETF has more of a history.

The fund follows the Deutsche Bank Global Government ex-U.S. Inflation Linked Bond Capped Index. In the past 12 months, that benchmark has returned 20.9%. About 12% of those gains were currency related and another 5% was associated with inflation adjustments. Another 2% came from coupon interest payments. Less than 1% came from price appreciation.

"So for U.S. investors, currency diversification is a key factor for WIP," said Tom Anderson, head of ETF research at Boston-based State Street Global Advisors.

The real yield on WIP is around 2.01%, reflecting a worldwide flight to quality as credit markets continue to struggle from the U.S.-led mortgage meltdown. Still, that's about the same yield as SSgA's domestic TIPS ETF, The SPDR Barclays Capital TIPS (AMEX:IPE).

Both tend to be longer-duration in nature. So does iShares Lehman TIPS Bond ETF (NYSE: TIP). But its real yield is running about 0.77% right now.

In the U.S., yields are at relatively low levels as demand for TIPS has driven prices up in the past five years. But since yields move in the opposite direction as price, interest payments on TIPS have been going down.

Right now, the real yield - or the amount you get paid in interest before any inflation adjustment is added - has been negative on TIPS. Last week, it moved up slightly on five-year U.S. TIPS.

It's important to note that real yields, while not including any official inflation adjustments, do generally reflect market inflation expectations. That can be seen in current nominal rates. The 10-year Treasury note is yielding 3.44% while a similar termed TIPS issue is yielding 1.10%.

The difference, or break-even inflation rate, is running around 2.34%. That's what traders are pegging their inflation expectations at right now. In theory, if inflation runs above that rate it would provide TIPS owners with greater total returns than non-inflation adjusted Treasuries.

In the same timeframe, prices on TIPS keep going up. For example, IPE has seen its share price rise more than 4.8% this year. That means most of IPE's total return of slightly better than 5% in 2008 has come from price appreciation.

By contrast, the Barclays U.S. Government Inflation Linked Bond Index generated an 11.6% return last year. About half of that return came from price appreciation with the other half split evenly between coupon interest and inflation-adjustment interest.

Since WIP has a significantly different return profile that's greatly enhanced at the moment from a declining U.S. dollar, the diversification benefits to a U.S.-only TIPS fund under current market conditions would appear to be greater.

The new WIP ETF also holds about twice the number of TIPS as the iShares fund. The biggest market in WIP is France at about 20% of the portfolio. That's followed by the U.K. at about 18% and Canada at nearly 6%. Brazil and Japan make up about 5% each of the portfolio as well.

Since the fund deals with government debt and buys in foreign currencies, it should be very liquid. Some of the ETF's currencies include the euro, yen, pound, Brazilian real and the krona.

WIP will use cash redemptions and cash creations instead of the typical U.S. ETF process which is all in-kind involving just stocks. But SSgA points out it uses the same process for the $700 million SPDR Lehman International Treasury Bond ETF (AMEX: BWX).

The expense ratio on WIP is listed at 0.50%.

Nusbaum cautions that going forward, investors betting on WIP's currency appreciation features might be somewhat disappointed.

While the ETF's getting a double-digit boost from the U.S. dollar's current slump, he says that's likely to moderate. Longer-term, Nusbaum says a more realistic expectation might be for WIP to gain around five to six percent of its returns from foreign currency appreciation.

"As a long-term holding, this global TIPS ETF looks like a great diversification tool," he added. "But people need to go into this type of a fund with realistic expectations. They need to take the current run-up in foreign currencies and TIPS in general with a grain of salt."

• More on Inflation Protected Bond ETFs