Allan Roth: LifeX's ETF Conversion a 1-Click TIPS Ladder

A TIPS ladder guarantees an inflation-adjusted annual cash flow for up to 30 years. I consider it Social Security Supplemental. It’s now less complex to build but wouldn’t it be nice to simply buy the ladder with one click? The conversion of LifeX mutual funds to ETFs is a giant step in the right direction. 

Let’s begin with a little background. Over a year ago, I challenged the financial services industry to develop an ETF to guarantee the 4% withdrawal rule over 30 years. Others thought the idea had merit including John Rekenthaler at Morningstar, David Enna at TIPSwatch, and Jason Zweig at The Wall Street Journal.

Earlier this year, I wrote about new LifeX mutual funds. While there was much to like, the 1% expense ratio and the fact they could only be bought through the advisor channel (with additional fees), ended up giving away most or all of the real (inflation-adjusted) yield. Quietly, LifeX just made changes for the good. 

Last month, Stone Ridge converted these mutual funds to ETFs. The new LifeX ETFs are in two classes—nominal and inflation-adjusted payouts. They are branded as LifeX but have the Stone Ridge name in each ETF. The nominal payouts are higher, of course, but are essentially playing Russian Roulette with inflation. 

Inflation Protected ETFs

So my review is on the inflation protected ETFs. The major improvements are reducing the expense ratio from one percent to 0.5% and making them available directly to the public. These ETFs are self-liquidating with real payouts where the investor can pick end years between 2048 and 2063.

I decided to compare the longest TIPS ladder that can be built to the Stone Ridge 2054 Inflation-Protected Longevity Income ETF (LIAK). Both are about 30 years. As of Oct. 17, 2024, LIAK produced a 4.73% annual distribution yield. That shocked me as building one directly with no expense ratio only produced a 4.37% distribution. With a $100,000 investment, that’s an annual distribution of $4,730 vs $4,370. How can it be that a fund with a 0.50% expense ratio pays more than building virtually the same TIPS ladder directly?

I dug in a little deeper and confirmed the answer with Nate Conrad, head of LifeX. In an interview, Conrad confirmed that the yield would likely be cut by about 25% once the fund was within 20 years of its maturity. So the 4.73% would be cut to an estimated 3.55% of the original investment, and there could be risk around that actual amount. Conrad explained that this is consistent with what’s known as the retirement spending smile, referring to a paper by researcher David Blanchett that demonstrated spending is higher in the earlier years of retirement when one travels more, then declines before going up again due to higher healthcare costs. Conrad told me one would have to have assets in other vehicles to help fund those later years.

The goal, however, according to Nathan Dutzmann, CIO at Round Table Investment Strategies, is that no distribution reduction would occur in that last 20 years if the fund holder converts to the planned offering of a closed-end fund. That closed-end fund will operate like a tontine with the goal to pay distributions as long as the person is alive, up until age 100. 

Dutzmann notes that, because of the longevity pooling, the aim would be that the distribution rate for women opting in this closed-end fund would not decline and would actually increase for males. Conrad confirmed that any such conversion would be a taxable event. 

Elisabeth Kashner, director of funds research and analytics at FactSet, told me “at present, trusting that the Stone Ridge will continue to support these products over a span of decades makes for a risky bet, as the ETF suite has not yet gathered sufficient capital to remain viable. The 16 ETFs comprising the TIPS suite had just $56.7 million in combined AUM as of October 9, 2024. 

The majority of the suite's assets seem to have come from their pre-conversion mutual funds and seed capital. Investor ETF flows have been slow.” In all fairness, this preceded their official public marketing campaign. The official announcement came on this October 16, 2024 press release.

Conrad responded to this concern by stating “We recognize that a retiree investing in a LifeX ETF is trusting us to deliver a key piece of their financial plan for the long-term, and we take that trust very seriously.” Conrad concluded “We have worked on LifeX for more than five years before launching, which shows our commitment to the product.”

My Analysis 

I applaud Conrad and Stone Ridge for making great improvements over their initial mutual fund products. They cut the costs in half and made it directly available to the public. In many ways, it goes beyond a build-it-yourself TIPS ladder in that it pays monthly (rather than annually), will fill in the five missing years (2035-2039) automatically, and may give access to a tontine like closed end fund for those at age 80. And, of course, buying one ETF is so much simpler than buying 25 or more issues of TIPS.

On the flip side, I don’t like the planned cut in the distribution rate. I’m less confident that retirement spending will be lower in ten years, especially if Medicare and Social Security endure more means testing. I prefer the idea of a fixed real spending floor to add on to whatever Social Security pays. And with the real yield of TIPS at about two percent, giving up 50 bps is ceding too much of the real income. But Conrad did tell me “we’ve decided to also commit to cut the fee in half again, to 0.25%, in the last 20 years of each ETF’s operations since the investment strategy becomes simpler to operate beyond that point.” 

While I think Stone Ridge is committed to this product, there is always the possibility that Stone Ridge closes the funds if they don’t attract enough assets to make a profitable business. I agree with Kashner who emphasizes that investors and advisors are on the hook to do their own due diligence. She says this means spending time understanding the products' payout features and cost structure.  

My challenge to the financial service was to create a TIPS ladder fund with constant real distributions and an expense ratio of no more than 0.10%. Stone Ridge is getting closer to meeting my challenge. This may be appropriate for someone wanting automated real yield distributions and willing to pay the extra fees.