In case you haven't noticed lately, inflation has been a problem. It started out as a "transitory" increase in prices due to supply chain disruptions that was largely expected to fix itself over the subsequent 12 months. Today, it's turned into a global spiral fueled by the conflict in Ukraine that's impacting food, energy and commodities prices with no end in sight.
That's sent investors fleeing into inflation protection strategies. Treasury inflation-protected securities, or TIPS, have become the natural landing spot. Gold is often considered a good inflation hedge, but prices remained mostly flat throughout 2021 up until only recently. When inflation was thought to be only temporary, investors had pretty much settled on just waiting it out. When it became a serious problem, gold got a lot more attention.
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The one area, however, that has consistently outperformed the broader Treasury bond market throughout this time has been TIPS. Investors sure have noticed too. Over the past 12 months, TIPS ETFs have taken in around $31 billion in new money. In a vacuum, this is a big number, but it's even bigger considering the fact that the entire TIPS ETF market is still under $100 billion in total even after these huge inflows. In other words, assets under management for TIPS ETFs have roughly doubled over just the past year.
TIPS ETFs are still receiving a lot of new money and are perhaps the hottest fixed income product in the marketplace today. The number of TIPS ETFs available to investors isn't huge, but it's more than enough variety that you can approach adding inflation protection to your portfolio in multiple ways.
Ranking The TIPS ETFs
The variety of ETF choices makes distinguishing the best from the rest a little challenging. You've probably heard most financial pundits talk about focusing on funds with low expense ratios. That can certainly be a big factor in deciding which ETF to go with (it's probably the most important factor, in my view), but there are a lot of things that could go into making the right choice.
That's where I'm going to try to make things easier for you. Using a methodology that I've developed, which takes into account many of the factors that should be considered and weighting them according to their perceived level of importance, we can rank the universe of available ETFs in order to help identify the best of the best for your portfolio.
Now, this certainly won't be a perfect ranking. The data, of course, will be objective, but judging what's more important is very subjective. I'm simply going off of my years of experience in the ETF space in helping investors craft smart, cost-efficient portfolios.
Methodology And Factors For Ranking ETFs
Before we dive in, let's establish a few ground rules.
First, all of the data is used is coming from ETF Action. They have gone through the ETF universe to identify and categorize those ETFs used here. There are many that qualify and we'll be using their categorization as a starting point. Many thanks to them for opening up their vast database for my use.
Second, let's run down the factors I used in the ranking methodology.
- Expense Ratio - This is perhaps the most important factor since it's the one thing investors can control. If you choose a fund that charges 0.1% annually over a fund that charges 1%, you're automatically coming out ahead by 0.9% annually. You can't control what a fund returns, but you can control what you pay for the portfolio. Lower expense ratios equal more money in your pocket.
- Spreads - This relates to how cheaply you can buy and sell shares. Generally speaking, the larger the fund, the lower the spreads. Bigger funds usually have many buyers and sellers. Therefore, it's easier to find shares to transact and that makes them cheaper to trade. On the other hand, small funds tend to trade fewer shares and investors often need to pay a premium to buy and sell. Considering expense ratios and spreads together usually give you a better idea of the total cost of ownership.
- Diversification - Generally speaking, the broader a portfolio is, the better chance it has at reducing overall risk. A fund, such as the Energy Select Sector SPDR ETF (XLE), provides a good example. 45% of the fund's total assets go to just two stocks - ExxonMobil and Chevron. By buying XLE, you're putting a lot of faith in just those two companies. An equal-weighted fund, such as the Invesco S&P 500 Equal Weight Energy ETF (RYE), would score higher on diversification than XLE.
- FactSet ETF Scores - FactSet calculates its own proprietary ETF ranking for efficiency, tradeability and fit. They basically are designed to tell us if an ETF is doing what it sets out to do. I'm not going to copy and paste that work that they're doing, but there is some influence there to make sure my rankings are on the right path.
There are a few other minor factors thrown into the mix, but these are the main factors considered.
One thing that is not considered is historical returns. Most ETFs are passively-managed and are simply trying to track an index, not outperform. ETFs shouldn't be penalized for low returns simply because the index they're tracking is out of favor at the moment.
I'm ranking ETFs based on more basic structural factors. Are they cheap to own? Are they liquid? Do they minimize trading costs? Do they maintain risk-reducing diversification benefits?
Being in the bottom half of the list doesn't automatically make a fund "bad". It simply means that due to a low asset base, a high expense ratio, a concentrated portfolio or some other factor, it poses additional costs or downside risks.
Top TIPS ETF Rankings For 2022
In a sector where there's not necessarily a lot of variety below the surface as there may be in sectors, such as tech or energy, TIPS ETFs mostly come down to what kind of maturities you want to target and what you want your duration risk to be. That narrows down this segment into 1) short-term TIPS, 2) long-term TIPS or 3) varied maturity TIPS.
Of course, as is the case with many of my ETF rankings, cost, liquidity and tradability are major factors.
As you can see, low cost wins out again. When slicing and dicing these ETFs apart, the difference between a 4-5 basis point expense ratio and a 12-15 basis point expense ratio can be huge. That's why the iShares 0-5 Year TIPS Bond ETF (STIP), the Schwab U.S. TIPS ETF (SCHP) and the Vanguard Short-Term Inflation-Protected Securities ETF (VTIP) occupy the top 3 spots. VTIP and STIP are clearly the most similar to each focusing on short-term TIPS. Both maintain a duration of around 2.5 years, so the risk/return profiles look very similar. SCHP invests in TIPS of all maturities and currently maintains a duration of around 7.5 years, so it's highs will be higher and lows will be lower. Looking at risk metrics, it's been about twice as volatile as SCHP/VTIP.
The SPDR Portfolio TIPS ETF (SPIP) and the iShares TIPS Bond ETF (TIP) round out the top 5. They come at a slightly higher cost, but look substantially similar to SCHP. Their durations come in closer to 8 years, so there's a very slight degree of higher volatility, but they're mostly the same type of offering from three different issuers.
If you're looking for a middle ground between these two groups, the SPDR Bloomberg 1-10 Year TIPS ETF (TIPX) might be it. It has a duration of just under 5 years and focuses on the short- and intermediate-term maturities, as the name suggests. For comparison's sake, SPIP has nearly 1/4 of the portfolio in maturities of 10-30 years, so TIPS would be a noticeable step down from that.
Among other key ETFs in these rankings:
If you want to venture out on to the riskiest end of the spectrum, there's the PIMCO 15+ Year U.S. TIPS Index ETF (LTPZ). The reward for this fund is potentially greater, as you can see by its historical returns, but it has a duration of a whopping 21 years. If inflation expectations come back down to earth again, LTPZ could be among the worst performers.
The Quadratic Interest Rate Volatility & Inflation Hedge ETF (IVOL) isn't your traditional TIPS ETF. It falls further down this list because of the expense ratio, but this is a case of needing to pay for what you're getting. IVOL starts with a portfolio of TIPS and adds long options tied to the shape of the U.S. interest rate curve. The fund’s strategy is designed to hedge against inflation risk and generate positive returns from the fund’s options during periods when interest rate volatility increases and/or the U.S. interest rate curve steepens.
The ProShares Inflation Expectations ETF (RINF) is another non-traditional TIPS-related ETF. It invests mainly in a portfolio of TIPS-linked swap contracts that are designed to provide exposure to the 30-year breakeven inflation rate, which is a widely followed measure of inflation expectations. It is not designed to reflect CPI or other measures of realized inflation. If you want to bet purely on inflation expectations, this might be the fund for it.