Saturday, January 26, 2013

5 ETFs to Fight Inflation

If your grandparents were the kind to bury cash in tin cans out in the yard, the time to cash in that change was yesterday.  Every penny not earning interest is fighting a constant battle with inflation, or the loss of purchasing power over time.  Why inflation occurs is debatable and likely constantly changing, but what investors should always be wary of is how it will affect their portfolios.

The United States Department of Labor calculates the rate of inflation monthly, reporting it as a change in the Consumer Price Index.  There is some contention on if the CPI method truly captures "real inflation", but for the most part its the best official method.

There are also a lot of investments that claim to "hedge inflation": precious metals, corporate bonds, municipal bonds; how these all fair might make a good post for Ulmer Scientific in the future...but any selective investor will always take a guarantee.  How can anyone offer a guarantee against inflation?!  Try the same folks who calculate it:

The U.S. Treasury offers one of the most novel (we think) investments of the past century: Inflation Protected Securities.

Treasury Inflation Protected Securities (or TIPS) are bonds sold by the Treasury with the promise to always keep pace with inflation.  Depending on how generous the Government feels they might even add in an extra base rate.  

I'm Sold, How Can I Buy TIPS?!:
Well, would have you believe you can buy them from the Treasury.  Good luck.  Oh by the way you can't buy paper bonds anymore.  I'll let you try out the website for a minute...

Back so soon?  Okay, luckily TIPS are traded on the open market and the exchange trade fund arena has answered investors' Treasury frustrations.  There are over a dozen TIPS ETFs with tens of dozens of mutual funds; in keeping our analysis brief, lets Google "best TIPS ETFs".  First pick, U.S. News and World Report's Best Fit TIPS ETFs.  Lets examine the Top 5:

  1. Schwab U.S. TIPs ETF (SCHP)
  2. SPDR Barclays TIPS ETF (IPE)
  3. PIMCO Broad U.S. TIPS Index Exchange-Traded Fund (TIPZ)
  4. PIMCO 1-5 Year U.S. TIPS Index Exchange-Traded Fund (STPZ)
  5. iShares Barclays TIPS Bond Fund (TIP)
Take some time to read U.S. News' ranking methodology, notice "yield" isn't considered (HEY!...that's why you're reading Ulmer Scientific).  Two things stand out instantly.  STPZ is the only duration specific fund, and TIP has been trading for years longer than its peers.  TIP is also happens to be the largest of the 5, pulling an order of magnitude more average dollar-volume:

What Does Inflation Protection Look Like:
Given all 5 of these funds have basically the same objective, we could expect their annualized returns to be approximately equal:

What Happened With STPZ?
We know STPZ holds the shortest duration TIPS, whereas the other 4 hold mostly longer durations.  As with most fixed-duration investments the longer you hold them the higher return you can expect to get (see Treasury Rates); the trade-off being your money is now tied up for the entire duration of the investment.  Not necessairly a good thing if you car stops working or an unexpected medical bill arrives.

 HOWEVER, with the advent of ETFs, investors can now actively trade multi-year investments and receive the same rate.  Knowing this, when any long term investor chooses yield over all else, we conclude STPZ is a fund for short-trades and speculation on inflation and not a sound investment.  Lets focus on the remaining 4.  Since these fund's APY-to-Dates are close, lets look at the difference they make from an average of all their yields:

At least according to this chart, IPE is the clear profit winner in the TIPS ETF world, pulling on average 0.15% higher in annualized yields. Conversely TIPZ has barely been able to keep pace with its competitors.  Also note TIP, with the largest share of the TIPS market, isn't always even at average.

The ETF universe is exciting and confusing at the same time.  Just because one article you read ranks a fund over another doesn't necessarily mean it'll earn you the most for your investment.  In the case of TIPS these differences are likely due to each fund's unique holdings, but they could be the result of higher fees, poor management, or any number of market conditions.

Check out how to calculate your own Annualized Percentage Yield charts here.

Read about the potential inflation hedging Gold ETFs here

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