A Vanguard study incorporating more than four decades of data shows that short-dated TIPS, when compared with equities and commodities, have the highest correlation with inflation. “They provide the best protection with the lowest volatility,” says Wright-Casparius.
Although not overtly exciting, TIPS makes sense for many investors. “If you are retired or near retirement, or if you are planning a future liability like a college education, TIPS can add insurance,” explains Wright-Casparius. “Making a reasonable allocation to TIPS makes sense because inflation has the potential, if it were to move sharply higher, to impact returns. And for retirees who cannot make up negative returns that insurance is needed.”
Moreover, buying this protection through ETFs rather than individual securities reduces a potentially unfavorable tax burden. “Both closed-end funds and ETFs attempt to avoid phantom income taxation by selling portions of their portfolio” to match the income and tax liability, notes Bank of America.
A Review Of ETFs
ETFdb.com includes 13 ETFs in its TIPS ETF category. These 13 can be divided into four sub-groups.
The first, a broad-based sub-group, features three ETFs tracking the Barclays Capital US Treasury Inflation Protection Securities Index (Series L). The iShares TIPS Bond ETF (TIP), the largest TIPS ETF, has assets under management of more than $23.3 billion. The Schwab U.S. TIPS ETF (SCHP), which charges the category’s lowest expense ratio at 0.05 percent, and PIMCO Broad U.S. TIPS Index ETF (TIPZ) round out this group.
Short-term inflation is the focus of the second sub-group. This category includes the Vanguard Short-Term Inflation-Protected Securities ETF (VTIP), the second-largest fund in the TIPS category at $3.7 billion AUM, and the iShares 0-5 Year TIPS Bond ETF (STIP). These two funds track the Barclays Capital US TIPS 0-5 year Index (Series L). Another short-term fund, the PIMCO 1-5 Year U.S. TIPS Index ETF (STPZ), tracks the Bank of America Merrill Lynch 1-5 year US Inflation Linked Treasury Index.
A third sub-group takes a long-term inflation view. Most notably, the PIMCO 15+ Year U.S. TIPS Index ETF (LTPZ) focuses on inflation out at least 15 years. Tracking the Bank of America Merrill Lynch 15+ year US Inflation Linked Treasury Index, this fund is useful for protecting against future inflation, but because of its long-term nature it is subject to more interest-rate risk.