Don’t Believe Inflated Yields From Inflation-Protected Bond Funds

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Mutual funds and exchange-traded funds that buy TIPS, or inflation-protected Treasury securities, show returns of 8% or more in a bond market where even 4% seems wacky. According to Morningstar, these funds raised about $ 36.3 billion in new money in the first half of 2021, a record for a six-month period since the inception of TIPS funds in the late 1990s.

If an 8% return tempts you to join them, listen. These funds that claim to fight inflation ironically inflate their own declared returns.

I’ve written about this problem before, but it’s never been worse. This week, each inflation-protected security was trading at a negative yield to maturity before inflation. Yet more than two dozen mutual funds and ETFs that hold these bonds show returns of 6%, 7%, or even 8% or more.

These returns are TIPSy

The reported returns of mutual funds and exchange-traded funds investing in inflation-protected government bonds vary widely, depending on how they calculate their income.

$ 36.99

28.85

18.43

12.38

9.67

2.62

1.48

0.58

Funds

Vanguard Inflation-Protected Securities (Admiral)

TIPS iShares Bond ETF

ETF Schwab US TIPS

PIMCO Institutional Real Yield

Fidelity Inflation-Protected Bond Index

SPDR TIPS ETF Portfolio

IBoxx FlexShares TIPS 3-Year Target ETF

Invesco Short Term Inflation Protection (R5)

Fund, Net Assets (Billions)

Vanguard Inflation-Protected Securities (Admiral), $ 36.99

TIPS iShares Bond ETF, $ 28.85

Schwab US TIPS ETF, $ 18.43

PIMCO Real Return Institutional, $ 12.38

Fidelity Inflation-Protected Bond Index, $ 9.67

SPDR Portfolio TIPS ETF, $ 2.62

FlexShares iBoxx TIPS 3-Year Target ETF, $ 1.48

Invesco Short Term Inflation Protection (R5), $ 0.58

Fund, Net Assets (Billions)

Vanguard Inflation-Protected Securities (Admiral), $ 36.99

TIPS iShares Bond ETF, $ 28.85

Schwab US TIPS ETF, $ 18.43

PIMCO Real Return Institutional, $ 12.38

Fidelity Inflation-Protected Bond Index, $ 9.67

SPDR Portfolio TIPS ETF, $ 2.62

FlexShares iBoxx TIPS 3-Year Target ETF, $ 1.48

Invesco Short Term Inflation Protection (R5), $ 0.58

How the hell can that be? Are investors expecting double-digit cost of living hikes? Or are fund companies exploiting a regulatory loophole for marketing purposes?

TIPS are notes and bonds, issued by the US Treasury, whose value varies with changes in the monthly consumer price index. As this measure of inflation increases, the principal value of each of these securities increases; the same is true of his interest payment. When inflation goes down, the value and interest of TIPS goes down along with it.

TIPS pay interest, although not much these days — a 5-year ticket sold in April has a coupon of 0.125%. Rather, much of the return comes from adjusting capital for inflation.

On websites and in other types of marketing, the funds display what is commonly referred to as the SEC return. This number is sky-high at the moment.

Under the rules of the Securities and Exchange Commission, the funds take “dividends and interest”Earned per share in the previous 30 days, deduct the expenses and annualize them. The resulting SEC return tends to be roughly what you would get if you multiplied the previous month’s net income by 10 or 12.

The SEC’s rules for calculating its return, however, do not say whether to include the inflation adjustment or leave it out.

And that gives fund companies a lot of leeway.

As the economy picked up, the consumer price index hit unusually high levels of 0.8% in May and 0.9% in June. These are monthly numbers, so funds that annualize them and include the principal inflation adjustment in their income have reported monster SEC returns. To believe in this return is to imagine that such random numbers are lasting.

Among the many examples this week were the $ 9.7 billion Fidelity Inflation-Protected Bond Index Fund (SEC yield: 7.11%), the $ 12.4 billion Pimco Institutional Real Return Fund (8, 2%) and the $ 29.2 billion (8.4%) iShares TIPS Bond ETF.

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“To help our clients make informed investment decisions,” says a spokesperson for Fidelity, “we [also] disclose the distribution performance of our bond funds, which better reflects the shareholder’s experience.

Distribution yield measures the income paid out to a fund, which may also include principal cost-of-living adjustments.

Steve Rodosky, co-portfolio manager of Pimco’s inflation-protected bond funds, says the company calculates and displays performance “in accordance with SEC rules.” Pimco’s disclosures also present the distribution yield and the estimated yield to maturity. As of July 14, for example, for Pimco’s 1-5 Year US TIPS Index ETF, the SEC yield was 8.79%; distribution yield, 6.89%; and the yield to maturity, 0.55%.

The US inflation rate recently hit a 13-year high, sparking a debate over whether the country is entering a period of inflation similar to the 1970s. Jon Hilsenrath of the WSJ examines what consumers can expect. ‘then wait.

“From a market expectation perspective, estimated return to maturity is a more stable indicator” than SEC return, said Daniel He, another co-manager of Pimco’s TIPS funds.

In addition to SEC yield, explains Karen Schenone, fixed income strategist for iShares, “investors should also look at yield to maturity and actual yield” (or TIPS income adjusted for the inflation rate). These metrics are also displayed on the iShares website and in other marketing materials.

Earlier this year, iShares added a pop-up warning to its website: “An unusually high 30-day SEC yield may be due to an increase in the rate of inflation, which may not be repeated. “

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At least $ 109 billion is invested in TIPS funds with SEC returns of 6% or more, according to Morningstar, or about half of the category’s total assets.

However, not all have chosen to report inflated returns.

State Street Global Advisors reports negative SEC returns on several funds, including SPDR Bloomberg Barclays 1-10 Year TIPS ETF and SPDR Portfolio TIPS ETF. Vanguard Group is also posting negative SEC returns on its TIPS funds.

“In my opinion, including the inflationary adjustment of the principal [in] the SEC’s performance is incredibly misleading, ”said Matthew Bartolini, head of ETF research at State Street Global Advisors. “This assumes that, in the future, the inflation reading from previous months will be persistent,” even though the consumer price index can vary widely from month to month. “And many don’t know it.”

Right now, “the market is experiencing very high inflation month over month, and a calculation that annualizes the increase in inflation may reflect an overestimated view of expected return,” said a carrier. word of Vanguard. “Our practice has been to avoid this adjustment, which makes the SEC’s returns on Vanguard funds with TIPS exposure appear to be lower than other companies. Conversely, during times when monthly inflation is negative, our SEC yield may appear higher. The company believes this approach represents the actual performance of its TIPS funds in a consistent and accurate manner, he said.

In short, you can’t earn 8% income in a 2% bond market. And funds that claim to protect against inflation should also protect their investors against exaggerated expectations.

Write to Jason Zweig at [email protected]

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