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Exchange traded funds based on Treasury inflation-protected securities earned a bad name in 2022 after many failed to protect against surging prices, but a manager claims its new launch on Tuesday solves their problem.
Investors pumped a record amount of money into Tips funds in 2021. But the unusually sharp nature of the inflation spike — and the speed of the US Federal Reserve’s rate-hiking response to it — caused many Tips to fall in price as yields rose markedly, swamping the benefits these Tips accrued from their principal being uplifted to reflect higher inflation.
In 2022, Bloomberg’s total return Tips index lost almost 12 per cent, virtually as much as the 12.5 per cent loss chalked up by the comparable index tracking regular US bonds — despite US consumer price inflation hitting 6.45 per cent.
“The products that were out there had significant exposure to duration risk [the risk that a bond’s price will fall in response to interest rate rises]. That gave you exposure to the interest rate risk. You were basically making more than one bet,” said Kenneth Lamont, principal of research at Morningstar.
Washington DC-based F/m Investments’ disarmingly simple solution to this problem is to build an ETF out of ultra-short duration Tips in order to minimise this duration risk.
During 2021 and 2022 “in the midst of once-in-a-generation inflation, [longer-dated Tips] actually lost money because of the rise in real yields,” said Alex Morris, president and chief investment officer of F/m.
“Many investors believed their inflation projection failed, which is incorrect. The duration exposure on those instruments cannibalised their inflation protection. [Tips funds] rebalanced every quarter and that locked in losses.
“We will buy the four to six Tips that have the lowest time maturity. We will be the first real tradable product that gives you that,” Morris added.
The F/m Ultrashort Treasury Inflation-Protected Security ETF (RBIL), based on a custom-designed index from Bloomberg, will hold Tips with a maximum maturity of 12.5 months and have an average duration of 90-120 days.
This stands in sharp contrast with anything currently on the market. Mainstream Tips funds such as the iShares Tips Bond ETF (TIP) and Schwab US Tips ETF (SCHP) have durations of about 6.6 years, according to their factsheets.
Even shorter-term vehicles targeting Tips with a maturity of up to five years, such as the Vanguard Short-Term Inflation-Protected Securities ETF (VTIP), iShares 0-5 Year Tips Bond ETF (STIP) and PIMCO 1-5 Year US Tips Index ETF (STPZ) have durations of between 2.3 and three years.
“Our index went up with CPI,” during the surge in inflation, Morris said. Data supplied to the FT suggested the index would have returned 4.6 per cent in 2021 and 2.9 per cent in 2022.
He compared RBIL’s simplicity to F/m’s family of single-bond ETFs, a concept that the company pioneered and that now accounts for $6.5bn of its $16bn in assets under management.
“It’s a boring, simple product,” said Morris. “It does what it says on the tin. It’s like watching paint dry. We think there is an opportunity for it in the adviser market,” with the $7tn currently held in US money market funds and $18tn in bank deposits and other cash equivalents among his targets.
Rather than buy RBIL, a US retail investor looking for a similar exposure could simply buy I bonds, analogous to Tips, from the US government’s TreasuryDirect website. If held to maturity, they will provide the hoped-for pure inflation protection, undiluted by any duration-driven impacts.
However Morris argued I bonds were “clunky . . . inelegant and flawed in many ways”. Investors are limited to buying $15,000 per taxpayer per year, of which a third must be held in paper format, while early redemption in the first five years incurs an interest penalty.
“I think there’s a space out there for it,” Lamont said of F/m’s ETF, although it had its flaws in his view.
“Having a vehicle that gives you liquid access is obviously a good thing. As an investor it’s a pure play on inflation. That’s what some investors want but it’s not giving you inflation protection across the curve.
“This is saying ‘we are only going to go ultra-short, so your yield will be lower because we are only focusing on short-term debt’.”
He noted that there were also some other assets that might give an investor inflation protection in the event of another spike, such as infrastructure, real estate and commodities.
RBIL will carry a fee of 0.25 per cent and will launch on the Nasdaq exchange with $50mn of seed capital. F/m is believed to be working on similar inflation-protected products for other countries, including the UK.
