Inflation Protection ETFs Are Climbing

April 07, 2016

(Reuters) – After months of angst about deflation that has led many central banks to adopt negative interest rates, there's been a sudden burst of speculation that inflation may be back.

In the United States and Britain at least, many investors are betting that inflation has reached its nadir and are seeking to insulate their portfolios against rising consumer prices.

Demand for U.S. Treasury inflation-protected securities is at its strongest in years, while benchmark TIPS exchange-traded funds have recently chalked up their best quarterly performance in 12 years.

TIPS purchases are being recommended by giant asset managers BlackRock and PIMCO and banks such as Morgan Stanley, while economists at Citi say the "lowflation" that has defined the U.S. and British economies in recent years seems to be ending.

‘Valuations Attractive’

"Even if core inflation stays where it is, buying a TIP will return 70 basis points more than buying a nominal Treasury bond," said Shyam Rajan, head of U.S. rates strategy research at Bank of America Merrill Lynch (BAML) in New York. "Valuations are very attractive. Breakevens are still cheap by any metric."

The yield premium on regular U.S. Treasurys is currently 1.75%, and the yield on TIPS is 0.15%, giving a breakeven rate of 160 basis points. With U.S. core inflation now running at 2.3%—a four-year high—investors can pick up a real return of 70 basis points.

Inflows Following Performance

Investors are flocking to TIPS products. According to BAML, investors have been net buyers of TIPS funds for seven-straight weeks, the longest run in almost a year. Cumulative inflows into these funds now stand at $4.8 billion, also the highest for nearly a year.

Moves this year in the benchmark TIP exchange-traded fund tell a similar story. The $16.7 billion ETF iShares TIPS Bond (TIP | A-99) rose 4.4% in the first quarter of the year, its best quarterly performance since the same three-month period in 2004.

Similar performance has been seen with the Schwab U.S. TIPS (SCHP | A-100) with $1 billion in assets; the SPDR Barclays TIPS (IPE | A-89), with $665 million in AUM; and the PIMCO Broad U.S. TIPS (TIPZ | B-87), with $89 million in assets.

Chart courtesy of StockCharts.com

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