Guarding Against Inflation For A Nominal Fee

When bond investors look to buffer their portfolios against the scourge of inflation, they often flock to Treasury inflation-protected securities, also known as TIPS. Exchange traded funds offer investors an avenue to TIPS and some of these funds come with nominal fees attached.

One of the dominant names among TIPS ETFs is the Vanguard Short-Term Inflation-Protected Securities ETF VTIP. VTIP “seeks to track an index that measures the performance of inflation-protected public obligations of the U.S. Treasury that have a remaining maturity of less than five years,” according to Vanguard.

For penny-pinching, inflation-fighting investors, VTIP is an attractive option. The ETF charges just 0.07 percent annually, or $7 on a $10,000 position, making it less expensive than 90 percent of rival TIPS funds, according to issuer data.

How TIPS Work

Changes in the Consumer Price Index (CPI) are the primary drivers of price action, which is usually benign, in funds such as VTIP. The Vanguard fund is up just under 1 percent this year. Due to its low duration, VTIP, as its name implies, is appropriate for investors concerned about changes in near-term inflation expectations.

“Gains and losses from the price volatility are mitigated thanks to the fund's short duration,” sMorningstar said in a recent note. “As a result, this fund more closely tracks the realized inflation fluctuations over the short run than its longer-duration counterparts do.”

One risk with TIPS and the corresponding ETFs is that if future inflation expectations are not realized, TIPS could be vulnerable to under-performing traditional government debt.

“But TIPS come out ahead when the opposite is true,” said Morningstar. “The break-even inflation rate refers to the rate that would equal the real return from regular Treasuries and TIPS with the same maturity.”

Low Yield

In exchange for its inflation-fighting potency, VTIP does not offer investors much in the way of yield, confirming the notion that TIPS usually aren't prized as income plays.

“But the fund offers a low yield. It returned 0.5% annually over the three years through September 2017, placing it in the category's bottom quintile. Its category peers gained 0.9% per year during the same period,” according to Morningstar.

VTIP has added $963 million in new assets this year.

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