Fresh inflation data is putting TIPS ETFs back under the microscope, raising a familiar question for investors: Are inflation-protected bond funds headed for another letdown just as inflation fears heat up again?
The Federal Reserve's preferred inflation gauge climbed to its highest level in nearly three years in April as the Strait of Hormuz energy shock continued to ripple through the economy. Headline Personal Consumption Expenditures inflation accelerated to 3.8% year over year, while gasoline and other energy goods surged 5.5% month over month after a 20.9% spike in March.
That backdrop has pushed investors back toward Treasury inflation-protected securities, or TIPS, ETFs. Yet the category's recent performance suggests many investors may still underestimate the interest-rate risks embedded in these funds.
The largest TIPS ETFs have seen net inflows since the Iran conflict escalated in late February despite rising inflation concerns. The Schwab U.S. TIPS ETF (NYSE:SCHP) has gained $113 million, according to ETFDb data, while the iShares TIPS Bond ETF (NYSE:TIP) saw $826 million in inflows. The State Street SPDR Portfolio TIPS ETF (NYSE:SPIP) also saw net inflows during this period.
Why TIPS ETFs Can Still Lose Money During Inflation
The recent weakness may appear modest, but strategists cited by MarketWatch say it highlights a structural issue with TIPS ETFs that became painfully clear during the 2022 inflation shock: Inflation protection does not eliminate duration risk.
One expert explained that buying a TIPS ETF isn't the same as buying a TIPS bond, because a TIPS ETF doesn’t hold its underlying bonds to maturity, increasing the risk of getting back less principal.
Unlike individual TIPS bonds, which guarantee investors receive an inflation-adjusted principal value if held to maturity, TIPS ETFs continuously trade baskets of inflation-linked securities across varying maturities. That leaves funds exposed to bond-price declines when interest rates rise.
The distinction became critical in 2022, when investors rushed into inflation-protected funds expecting them to offset soaring prices, only to discover that aggressive Federal Reserve rate hikes crushed bond valuations across the market.
BlackRock's TIP posted losses of more than 12% in 2022. Meanwhile, the SCHP lost more than 6% during the same year, according to FactSet data.
Floating-Rate Treasury ETFs Are Emerging As An Alternative
Still, fixed-income strategists warn that many retail investors may once again be treating TIPS ETFs as direct inflation insurance rather than long-duration bond funds with inflation-linked features.
According to MarketWatch, TD Securities explained that investors in 2022 were "unpleasantly surprised" after inflation-protected funds failed to shield portfolios from losses during the Fed's tightening cycle.
That concern is drawing attention toward floating-rate Treasury ETFs, which are designed to adjust more quickly to changing interest rates.
Treasury floating-rate notes may offer cleaner protection against persistent rate volatility because their coupons reset higher as rates rise.
Funds such as the WisdomTree Floating Rate Treasury Fund (NYSE:USFR) have begun benefiting from that shift in positioning. The ETF has gained more than $930 million since Feb 28.
For ETF investors, the latest inflation spike may be reviving the same lesson the market learned during the post-pandemic inflation surge: Inflation protection is not the same thing as protection from rising interest rates.
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