As the Federal Reserve tightens monetary policy, longer-dated fixed-income plays are taking it on the chin.
Bond funds with longer duration are more sensitive to interest rate changes because their price fluctuations are more pronounced, which is why many longer-dated fixed-income exchange-traded funds are weaker this year.
That’s seen in popular bond funds like the iShares 20+ Year Treasury Bond ETF (TLT), down 5.9 percent, Vanguard Long-Term Corporate Bond Index Fund ETF Shares (VCLT), down 6.2 percent and Vanguard Long-Term Bond Index Fund ETF Shares (BLV), down 5.9 percent.
One long-dated bond ETF is bucking the trend. The ProShares Inflation Expectations ETF (RINF) is up 6.5 percent year-to-date. Its one-year return is 9.3 percent and its annualized three-year track record is up 2.1 percent. It’s down 2.9 percent on a five-year basis. The 12-month yield is 2.96 percent and its expense ratio is 30 basis points. RINF has $11.7 million in assets under management. The Morningstar Risk Measure says RINF has high risk versus the category average.
The fund tracks the performance of the FTSE 30-Year TIPS (Treasury Rate-Hedged) Index. It’s designed to provide exposure to 30-year breakeven inflation, but doesn’t reflect the consumer price index or other measures of realized inflation.
Treasury inflation-protected securities are an inflation-indexed treasury security designed protect investors from the negative effects of inflation. The U.S. Treasury says TIPS pay interest every six months. The interest rate is a fixed rate determined at auction, but the interest payments vary because the rate is applied to the adjusted principal.
TIPS have floundered during the past several years because there’s been little inflation despite the extraordinary monetary policy moves by the Fed and other global central banks in the wake of the financial crisis 10 years ago. However, market watchers are looking for signs of rising inflation as the economy picks up. TIPS are available in 5-, 10-, and 30-year maturities, and most ETFs that invest in TIPS indexes focus on the 5- and 10-year maturities.
RINF gives buyers a way to profit from increases in the market’s expectation of inflation. To do so, the fund buys 30-year TIPS and sells a similar amount of duration-adjusted U.S. Treasury bond positions (mostly futures and swaps), attempting to achieve an overall effective duration of zero. The fund is rebalanced monthly.
Simeon Hyman, global investment strategist for ProShares, says hedging out the duration risk is key to the fund’s strategy.
“Duration is the thing that people forget about with TIPS,” Hyman says. “People think, well, I'm going to buy these TIPS and they’re inflation protected, so all is well. But these are still bonds with duration risk and they're subject to the risk of interest rates rising. Even if you get some adjustments from changes in expected inflation, you can still lose money because overall interest rates go up.”