Inflation Indexed Notes ETFs Piece #2

In our last piece we described the inflation indexed notes market along with some of its attributes as they relate to the current inflation environment. Despite the somewhat narrow opportunity set in this market for managers to explore, there are numerous products both within the mutual fund and ETF market.

There are three major segments for an investor within this arena; US only TIPS, Global-ex-US and Global inclusive of US TIPS.

US only ETFs are typically passively managed and are either short or long-term in duration. Below we describe two of the largest in terms of AUM.

 

TIP-I-Share Barclay Tips Fund ETF-$12 Billion AUM-Passive

Country Exposure: US

Zenith insight-While CPI may increase, the duration risk 7.66 (interest rate) is high given the current low state of real interest rates. It will perform largely in line with the overall US inflation notes market but has little ability to manage duration and to be able to monitor expensive or cheap securities.

 

STPZ-PIMCO 1-5 Year US TIPS Index ETF-$1.3 Billion AUM-Passive

Country Exposure: US

Zenith insight-This has the same US TIPS specific risk as the TIP product as it cannot navigate across maturity or inflation expectations. It does however posses much less duration risk at 2.53. This may be reasonable for a firm that desires US only exposure and less duration risk.

 

There is also an option to abandon the US TIPS market completely and invest in an ETF that holds non-US global inflation notes although we do not believe this is a prudent move to exclude one of the largest and potentially rewarding TIPS market in the US.

 

WIP-SPDR DB International Government Inflation-Protected Bond ETF-$976 Million-Passive

Country Exposure UK 20%, France 18%

The remaining country exposure is reasonably evenly weighted.

Zenith Insight-The performance of this ETF is dependent on the performance of two countries that are close to 40% of the fund. The 10 real duration risk as well as the credit quality that is not AAA such as with an all US TIPs fund warrants close examination as this can affect your portfolios overall credit. An investor needs to possess the conviction that UK and France hold potential for a decrease in real interest rates.

It makes more sense to us to look at a US inclusive global fund for those firms that want to gain exposure to the larger inflation indexed note opportunity set. Pimco, given its massive size and budget is able to provide another offering in the ETF TIPS space.

 

ILB-PIMCO Global Advantage Inflation-Linked Bond Strategy Fund-$139Million-Active

This is an actively-managed exchange-traded fund composed of primarily high-quality inflation-linked bonds that span developed and emerging markets. The fund will normally invest at least 80% of its assets in inflation-linked bonds

Country Representation-US 20%, EU-25%, Brazil 19%, EM 10%

Zenith Insight– This offering does hold appeal. It is actively managed so country exposure will change over time to accommodate varying inflation expectations. It also is a multi-currency fund that can provide additional diversification benefits as well as active exposure to promising inflation markets. Its duration risk is in below that of WIP that stands at 10 and is roughly in line with a US only TIPS ETFs.

 

This piece was meant to outline the major choices for your investment committee with regard to inflation indexed notes within the ETF sphere. Through examples the basic choices are there for your review. In our next piece we will review actively managed mutual funds to aid in your vetting process.

 

Sincerely,

Tom Koehler-CIO