With interest rates on the move, investors can counter with Treasury inflation-protected securities (TIPS) or, more specifically, the Vanguard Short-Term Inflation-Protected Securities Index Fund ETF Shares (VTIP ).
With inflation on the rise, the Federal Reserve is looking to raise rates this year. If rates are going to rise on the short-term horizon, bonds can be susceptible to interest rate risk, but a fund like VTIP can help shorten duration.
VTIP seeks to track the Bloomberg U.S. Treasury Inflation-Protected Securities (TIPS) 0-5 Year Index performance. The index is a market capitalization-weighted index that includes all inflation-protected public obligations issued by the U.S. Treasury with remaining maturities of less than five years.
- Seeks to track an index that measures the performance of inflation-protected public obligations of the U.S. Treasury that have a remaining maturity of less than five years.
- Designed to generate returns more closely correlated with realized inflation over the near term and offer investors the potential for less volatility of returns relative to a longer-duration TIPS fund.
- Given its shorter duration, the fund can have less real interest rate risk and lower total returns relative to a longer-duration TIPS fund.
- Invests in bonds backed by the full faith and credit of the federal government and whose principals are adjusted semiannually based on inflation.
- Can provide protection from inflationary surprises or ”unexpected inflation.”
Advantages of an ETF Wrapper
One of the advantages of using an ETF as opposed to investing in individual TIPS holdings is the avoidance of cash drag — in particular, paying for taxes on unrealized gains when the value of the TIPS rise.
“Investors can avoid the cash drag of paying tax on unrealized increases in TIPS’ face value by investing through mutual funds or ETFs,” a Wall Street Journal article explains. “These funds generally pay cash dividends reflecting both the interest earned on the TIPS they hold and their face-value increases. They do this by using new cash inflows or proceeds from bonds being sold or maturing. Investors still have to pay tax on the dividends, but not before they get the benefit of the face-value increases.”
“Although interest rates on new TIPS are just 0.125%, TIPS funds paid an average cash yield of 4.5% in 2021—triple the level paid in 2020—according to Morningstar,” the article adds.
For more news, information, and strategy, visit the Fixed Income Channel.