RINF: Better Than TIPs Funds

Summary

• The RINF ETF gives investors a duration hedged exposure to 30Yr TIPS bonds.
• The RINF ETF does not pay a distribution, as its exposures are synthetically created.
• Investors should own RINF when inflation expectations are rising.

Khanchit Khirisutchalual

In my personal quest to find investments that would do well in the current inflationary environment, I came across the ProShares Inflation Expectations ETF (NYSEARCA:RINF).

I believe the RINF ETF is an excellent fund to own in the current environment where inflation is high and inflation expectations are ratcheting higher. It mimics a pairs trade between a portfolio of TIPS bonds against a portfolio of equivalent duration treasury bonds. This isolates the exposure to rising inflation expectations.

Fund Overview

The ProShares Inflation Expectations ETF provides investment results that track inflation expectations. The RINF ETF has been around for a while (inception date January 10, 2012), but has not caught on as inflation had not been an issue in the past decade.

Strategy

The RINF ETF seeks to achieve its investment objective by tracking the performance of the FTSE 30-Year TIPS (Treasury Rate-Hedged) Index. ProShares describes the Index as:

The Index tracks the performance of (i) long position in the most recently issued 30-year Treasury Inflation-Protected Securities (“TIPS”); (ii) duration-adjusted short position in U.S. Treasury bonds of, in aggregate, approximate equivalent duration dollars to the TIPS; and (iii) a cash equivalent security that represents the repo rate earned on the short position. The Index is designed to measure the performance of the Break Even Rate of Inflation (BEI). The Index is not designed to measure the realized rate of inflation, nor does it seek to replicate the returns of any index or measure of actual consumer price levels. The Index is constructed and maintained by FTSE International Limited. The Index is published under the Bloomberg ticker symbol “CFIIRINF.”

Readers who follow my work will notice the similarity between the RINF ETF's index construction and a pairs-trade idea from my article on the iShares TIPS Bond ETF (TIP). In the article, I described how one can still benefit from the inflation protection of TIPS bond without the duration risk. Here's an excerpt of what I wrote:

One potential solution to the problem above is to hold the TIPS-focused fund like the TIP ETF, hedged with a short position in the iShares 7 - 10 Year Treasury Bond ETF (IEF) or some similar ETF.

What RINF ETF does is exactly my 'pairs trade' strategy. ProShares will take care of the duration hedging in exchange for a fee.

Portfolio Holdings

Instead of actually holding TIPS bonds and shorting treasury bonds to hedge the duration, the RINF ETF replicates this exposure by holding total return swaps against large investment banks like Citibank (C) and Societe Generale (OTCPK:SCGLF) (Figure 1).

Figure 1 - RINF ETF holdings (proshares.com)

There are pros and cons to having synthetic exposures. The advantage is that the RINF ETF can have exact exposures without constantly trading and adjusting its holdings. As we can see in Figure 2, the RINF ETF has 100% long exposure to 30-Year TIPS.

Figure 2 - RINF ETF long exposure (proshres.com)

It also has 175% short exposure to treasury bonds with a 2048 maturity. Presumably this is to match the duration of the long TIPS position (Figure 3).

Figure 3 - RINF ETF short exposure (proshares.com)

On the downside, the RINF ETF introduces counterparty risk to the investment banks selling the total return swaps to the fund. Given the counterparties involved are Citibank and Societe Generale, both Global Systemically Important Banks ("Global SIBs"), this counterparty risk is low.

Returns

The RINF ETF has delivered strong performance in the shorter-term timeframes, as inflation expectations have increased dramatically in the past year. The RINF ETF has 1/3/5/10Yr average annual returns of 6.8%/8.9%/4.9%/-0.6% to September 30, 2022 (Figure 4).

Figure 4 - RINF ETF returns (proshares.com)

Distribution & Yield

The RINF ETF does not pay a current distribution.

One of the downsides of the RINF ETF compared to the pairs trade (long TIP/short IEF) is that the RINF ETF has synthetic exposures. This means it doesn't actually own the underlying bonds, so it does not earn any income. On the other hand, the TIP ETF pays a 7.56% trailing yield while the IEF ETF pays a 1.79% trailing yield, so the pairs trade earns a 'positive' carry. This may be important for some investors who desire a current yield from their investments.

Fees

The RINF ETF usually charges 0.97% expenses. But with fee waivers to September 30, 2023, the fee has been reduced to 0.30%.

Figure 5 - RINF ETF Fees (RINF ETF Prospectus)

When To Own RINF?

As mentioned above, the RINF has had strong performance in the past few years, but its longer-term performance has been poor with 10Yr average annual returns of -0.6%. What is going on and when should investors own RINF?

The simple answer is that investors should own the RINF ETF when inflation expectations are rising. Figure 6 below shows the RINF ETF overlaid on the 30Yr inflation expectation rate. By design, the RINF ETF aims to track long-term inflation expectations like the 30Yr inflation expectation rate (or more commonly called the "breakeven rate").

Figure 6 - RINF vs. 30Yr Breakevens (Author created with price chart from stockcharts.com and breakeven data from St. Louis Fed)

The longer answer is that in the past few decades, the world has experienced generally mild inflation, so long-term inflation expectations were well anchored around 2% and declining, which caused a steady decline in RINF's value. However, the COVID-19 pandemic was a large deflationary shock, which saw 30Yr breakevens plunge to 1.29% and RINF drop below $20 / share. The subsequent massive government stimulus combined with COVID-induced supply constraints boosted inflation expectations with 30Yr breakevens currently sitting at 2.33%. This has sparked an 80% rally in RINF from the COVID lows.

Short term inflation measures have been soaring in the past year, far above the central banks' 2% inflation target. For example, the latest September U.S. Consumer Price Index ("CPI") came in at 8.2% YoY and the Fed's preferred inflation measure, the PCE Price Index increased 5.1% YoY.

Looking forward, there are significant risks that high inflation is becoming 'entrenched' in consumers' minds. Every monthly inflation reading with a 6, 7, 8%-handle 'normalizes' the high inflation rate and leads to a wage-price inflation spiral. Already, we are seeing signs of wage related unrest, with U.S. rail union workers threatening a strike to demand higher wages. Similarly, Delta airline pilots are threatening strike actions. In the latest ADP jobs report, workers who stayed in their current job saw wage gains of 7.7%, while those who changed jobs saw 15.7% wage growth. The longer this bout of high inflation drags on, the higher inflation breakevens will go.

Conclusion

In summary, the ProShares Inflation Expectations ETF is an excellent fund to own in the current environment where inflation is high and inflation expectations are ratcheting higher as it risks becoming entrenched. However, if the Fed is successful in taming inflation in the coming quarters, investors should avoid the RINF ETF.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in RINF over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.