We’ve all heard of TIP, right? If you’re a long term commodities investor that buys on the dips, you might use this highly liquid ETF as the short term place for your dry powder. In theory, it protects from inflation, since the ETF holds only Treasury Inflation-Protected Securities (TIPS). In practice, the return on these TIPS is based on the movement of the CPI over time. Is this a problem? Depends whom you ask.
If you were somehow able to ask Ben Bernanke or Tim Geithner, I can hazard a guess what their answer might be: something like, “Of course the CPI tracks inflation, and of course TIPS protect investors from inflation… what are you, some crazy Ron Paul guy?”
If you ask John Williams, the creator of ShadowStats.com, the answer would be quite different.
If you’re not familiar with Mr. Williams, you might assume the above numbers are a concoction of personal opinion or wacky theory. In actuality, the numbers above represent the estimate of inflation over time as if it were calculated the same way it was in 1990! And no, your eyes don’t deceive you: according to the ShadowStats calculations, the annual inflation rate in the US has lately ranged between 5% and 13%. Suddenly TIPS don’t seem like such a great inflation hedge, after all.
Alternative ETFs That Fight Inflation
Long term investors are quite right to fear inflation, and prudently attempt to protect their assets from being eaten away by it. [See: Should You Buy Gold Before QE3 is Announced?] On the physical side, gold and silver are usually the backbone of a “hard asset” portfolio. For non-physical investments, most investors use very blunt instruments such as gold ETFs and TIPS ETFs. But even assuming you are comfortable with your previous metal holdings, whether they are in physical or ETF form, you might want to consider some inflation-fighting ETFs that hold something besides TIPS.
I asked Michael Johnston, Co-founder of ETF Database (and occasional contributor to Commodity HQ), for his recommendations. Mr. Johnston graciously allowed me to re-print snippets of the ETFdb Analyst Reports for each of the five ETFs he suggested. (If you’re interested in access to analyst reports for each of the 1,000+ US-listed ETFs, as well as a wide array of all-ETF sample portfolios and an advanced screener tool, consider a free seven day trial of ETFdb Pro.)
- CPI: “CPI seeks to deliver a real return over inflation, using a variety of different asset classes… this fund shouldn’t be expected to deliver huge absolute returns in most environments, but can be an effective tool for smoothing overall portfolio volatility and adding a non-correlated asset to the mix. CPI may become especially attractive when concerns over inflation intensify; we believe this ETF is a better choice than TIPS when prices begin to rise.” Read the entire ETFdb Pro Analyst Report for CPI.
- RRF: “RRF’s core position is in inflation-protected bonds, securities with distributions that are tied to the prevailing rate of inflation. Unlike many ETFs that offer exposure to this asset class, RRF offers impressive geographic diversification; the underlying portfolio consists of U.S. TIPS, as well as bonds from issuers in developed and emerging international markets. That feature should be appealing to anyone looking to take a global approach to inflation defense, and can be useful since inflation tends to occur unevenly across the globe. The exposure to commodities is also a critical part of RRF, and this segment is further divided into a long only strategy, a long/short piece, and steady exposure to gold.” Read the entire ETFdb Pro Analyst Report for RRF.
- FLOT: “This fund can be used as a tactical allocation in environments where interest rates are expected to rise, shielding investors from interest rate increases. It can also be used to round out fixed income exposure in a long-term portfolio, providing exposure to credit risk while minimizing interest rate risks. This ETF focuses on investment grade, dollar-denominated debt (though the underlying portfolio includes issuers from several different countries).” Read the entire ETFdb Pro Analyst Report for FLOT.
- WIP: “This ETF can be thought of as the international counterpart to TIP, as it offers exposure to inflation-protected bonds issued by primarily European governments. Because the principal of the underlying holdings adjust with inflation, these securities have become popular as a tool to protect against rising asset prices and a jump in CPI.” Read the entire ETFdb Pro Analyst Report for WIP.
- GTIP: “Unlike many funds in the Inflation Protected Bonds ETFdb Category, GTIP includes international exposure. This geographic diversification can be valuable within a fixed income portfolio; most investors maintain a strong home country bias when building bond exposure that can limit the effectiveness of this asset class. Given the broad focus of this fund, GTIP may be useful as a component of a long-term portfolio, complementing the exposure offered by funds such as AGG or BND (which have no international exposure). However, investors should take note of some of the limitations surrounding TIPS as a tool for protecting against inflation; the underlying assets of GTIP are bonds, and as such may be adversely impacted by increases in interest rates (which tend to occur in inflationary environments).” Read the entire ETFdb Pro Analyst Report for GTIP.
Ultimately, there’s no silver bullet for surviving the ravages of inflation, any more than there’s a silver bullet for surviving over-taxation. The good news is, ETFs are allowing investors more access than ever to a diverse range of niche asset classes that may outperform during inflationary environments. For more information about ETFs, including a dozens of model portfolios for every conceivable investing temperament and scenario, check out ETFdb Pro.
Disclosure: The author is long TIP, WIP, GLD, and physical gold and silver.