Time To Be Tempted By TIPS ETFs?

With inflation hardly a part of the conversation for many fixed income investors, 2015 has not been kind to Treasury-Inflation Protected Securities (TIPS). Confirming the notion that inflation is not a primary concern for advisors and investors are slumping commodities prices.

Exchange traded funds tracking multiple commodities are saddled with double-digit losses as are the major futures-based oil ETFs. Not to mention gold remains mired in a two-year bear market. The yellow metal is often a prime destination when investors are fretting about inflation.

"Recently, according to Bloomberg data, inflation expectations, as measured by the difference in yields between the government's TIP indices and its Treasury indices, have dropped, with 10-year expectations hovering around 1.5 percent, well below the long-term average. There are a number of logical explanations for this. For instance, the recent drop in inflation expectations has followed a drop in oil prices," said BlackRock Global Chief Investment Strategist Russ Koesterich in a recent note. 

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Investors' lack of faith that inflation is a legitimate issue has sent the iShares TIPS Bond ETF TIP to small year-to-date loss while the iShares Barclays Aggregate Bond Fund AGG, the world's largest fixed income ETF, has posted a 2015 gain of 1.2 percent. 

"In addition, despite persistent fears of Fed-induced inflation, a deleveraging consumer and modest credit growth have resulted in sluggish growth in monetary aggregates. As of June, U.S. monetary velocity was close to a record low, while year-over-year growth in M2 is stuck at 6 percent, below the long-term average, as numbers accessible via Bloomberg show. For the inflation bulls, except for some anecdotal and episodic signs of wage inflation, there isn’t much to offer comfort," adds Koesterich.

Flows data suggest some investors are banking on higher inflation. In what has been banner year of asset-gathering by fixed income ETFs, TIP has added more than $1.4 billion in new assets, putting a modest dent in the more than $8.4 billion combined the ETF bled in 2013 and 2014. 

To this point in the fourth quarter each of the top four ETFs in terms of new assets added are bond ETFs, but none are TIPS funds. The other rub with TIPS is that investors trade yield for inflation protection. For example, TIP has a real yield of just 0.46 percent.

"How the Fed will extricate itself from a bloated balance sheet is unclear, as ultimately is the long-term outlook for inflation. With that in mind, today’s modest break-evens suggest that TIPS offer some benefit to investors looking for a long-term inflation hedge," notes Koesterich.