Demand for inflation-linked bond index funds has increased in recent months as investors seek to hedge against sharply rising prices around the world.
So-called bond ETFs recorded net inflows of global investors of $ 31.7 billion in the first nine months of 2021, more than double the $ 15.7 billion they attracted overall. last year, according to ETFGI, a London-based consulting firm.
Total assets held in inflation-linked ETFs reached $ 114 billion at the end of September, up 39.5% from $ 81.7 billion at the end of last year, according to the ETFGI.
Deborah Fuhr, founder of ETFGI, attributes the sudden change to recent large increases in the cost of living, globally. “Investor concerns about inflation are driving inflation-linked bond ETFs into ETFs,” she says.
114 billion dollars
Total assets held in inflation-indexed ETFs at end-September – up 39.5% from $ 81.7 billion at the end of last year
These concerns are now at such a level that they are pushing flows to inflation-linked bond ETFs – previously considered a niche product in most investor portfolios – before flows to traditionally more popular categories, such as than corporate bonds, high yield bonds and emerging markets. ETF, notes Fuhr.
And the flows only underscore how difficult it is for bond investors right now, according to Michael John Lytle, managing director of Tabula Investment Management, a fixed-income ETF provider. He points out that they are facing a time of great uncertainty where the so-called experts have little to do.
“Economies are not very good at growing rapidly with unknown dynamics,” observes Lytle – referring to the rebound from the global contraction caused by the Covid-19 pandemic. He adds that the world has entered a phase in which “tipsters” “are indeed speculating on when prices will come down.”
“Anything is possible,” Lytle said. “What has happened over the past few months is tipsters are all over the map.” Usually, he points out, there would be a lot more consensus.
“Investors therefore need inflation hedging tools that they have never needed before,” he adds.
However, ETF investors should also have some understanding of how the underlying bond securities work, so that they can understand the type of protection they are buying.
Inflation-protected ETFs generally offer a choice of protection based on actual or expected inflation. The inflation protection achieved is provided by products that track indexes of simple inflation-protected US Treasury securities (Tips) or other inflation-linked bonds that track price index data at the consumption. Advice and similar links are therefore retrospective, in that they are based on obligations linked to reported inflation measures.
Alternatively, investors can choose to invest in ETFs that track an index of inflation expectations, also known as the breakeven rate.
Tabula believes that its US Enhanced Inflation Ucits ETF (TINF) is unique in that it provides exposure to both.
When choosing inflation-protected ETFs, investors should also consider the duration of the underlying securities. “The longer the duration of the instrument, the more exposed you are to changes in interest rates,” explains Lytle. Much depends on how long an investor plans to stay invested and whether he believes the current sharp rise in inflation will be transient or set in.
Market views on this exact point quickly changed. For example, short-term government bond yields soared in October, as the market began to integrate anticipated central bank rate hikes.
Medium-term bond funds have been the preferred choice for investors in recent months.
The $ 35.7 billion iShares TIPS Bond ETF (TRICK) – which invests in bonds with a range of maturities – drew the lion’s share of inflation-protected bond ETF flows, raising $ 8.4 billion in the year to October 21, according to CFRA data. At the end of October, holdings in the iShares fund, the largest inflation-protected ETF in terms of assets under management, had a weighted average maturity of around 8 years. Bonds with a maturity of 3 to 5 years made up the largest proportion of the portfolio, at around 23 percent, but almost 16 percent of the portfolio consisted of bonds with a maturity of more than 20 years. The fund did not hold bonds with a maturity of 10 to 15 years.
Schwab’s $ 21.4 billion U.S. ETF Tips (SCHP) – another linker ETF that the CFRA would consider a mid-maturity product with a weighted average maturity of around 8 years – ranked third for inflows. He accumulated $ 6.7 billion in the same 12 month period.
Two short-term bond ETFs were ranked second and fourth. The short-term, inflation-protected, $ 18 billion Vanguard ETF (VTIP) attracted $ 7.4 billion, while the $ 7.4 billion iShares 0-5 Year Tips Bond ETF (STIP) attracted $ 4.2 billion in inflows.
In contrast, the Pimco fund of US $ 880 million over 15 years and more Index Exchange Trade Fund (LTPZ), which has an effective maturity of over 23 years, had attracted just $ 120 million.
While inflation has made the headlines, analysts are not suggesting that investors should move a significant portion of their portfolios to ETFs that offer protection against rising prices.
“It’s not about shifting your portfolio to 50% inflation products, that would be insane,” says Lytle. He suggests that investors should always try to build portfolios that they believe will generate the best returns.
Todd Rosenbluth, head of ETF and mutual fund research at New York-based CFRA Research, agrees that bond ETFs should only be part of an allocation strategy. “Inflation-protected ETFs are a good fit for some portion of your fixed income exposure,” he says. His advice is that investors consider using these products for part of their exposure to US Treasuries – or as a replacement for that existing exposure.