After several years in the shadows, Treasury-Inflation Protected Securities (TIPS) ETFs are making a comeback. Last year, they had inflows of $9 billion, over three times the amount they drew during 2015.

The obvious draw has been an upward shift in the Consumer Price Index, the bogey that drives the securities’ increase or decrease in principal. Rising prices for energy and other commodities, in particular, are convincing investors that the days of ultra-low inflation may be in the rearview mirror. And while inflation is still under the Fed’s 2% target, that’s pretty low compared with the average 4.1% annual increases in that rate from 1970 to 2015.

TIPS have a number of attractive attributes, including their airtight credit status as obligations of the U.S. government. Their low correlation to equities makes them a good diversifier. And with the introduction of TIPS ETFs over a decade ago, they’re easier than ever to buy and sell.

They also come with some risks that many investors overlook, or don’t completely understand.

• A fixed coupon means they can lose value when rates rise, even though their principal inflation adjustment might help moderate the impact under some market conditions. That scenario played out in the last quarter of 2016, when higher expectations for inflation and an uptick in interest rates kicked in at the same time. During that period the iShares U.S. Treasury Bond ETF (GOVT) fell 4%, while the iShares TIPS Bond ETF (TIP) fell by a more modest 2.64%.

• They suffer losses when deflation hits. In the second quarter of 2013, some TIPS ETFs fell about 7% after the Federal Reserve’s “taper tantrum” signaled that slow economic growth and anemic inflation were likely to linger.

• TIPS ETF durations are higher than they are for those following traditional Treasurys, making them potentially more volatile. For example, GOVT has an effective duration of 5.9 years and a three-year standard deviation of 3.56%, while the TIP fund has an effective duration of 7.56 years and a standard deviation of 4.24%.

Sal Bruno, the chief investment officer at IndexIQ, says that TIPS’ volatility often comes as something of a surprise to investors, who may have thought they were buying a fairly staid investment. “The duration component leads to excessive volatility in an asset that many people look to for a consistent real rate of return,” he says. “TIPS are just too risky to be an effective inflation hedge, especially at times when inflation is relatively tame but interest rates are rising.”

Bryce Doty, a senior vice president at Sit Investment Associates in Minneapolis, says that while TIPS may be volatile, using them with other investments can effectively balance out their duration risk. His firm does that by using TIPS ETFs in conjunction with a floating-rate bond ETF such as the iShares Floating Rate Bond ETF (FLOT), whose interest payments adjust to reflect changes in interest rates, or with an ETF designed to increase in value when rates go up, such as the Sit Rising Rate ETF (RISE).

Others see shorter-duration TIPS ETFs as a good way to bridge the gap between inflation and volatility. “Lower-duration TIPS funds’ headline yield may be lower, but their portfolio impact may be more beneficial than broad-based TIPS because of their shorter duration,” says David B. Mazza, head of ETF and mutual fund research at State Street Global Advisors. In a similar vein, Morningstar analyst Brian Moriarty opined in a report that short-term TIPS funds “can be attractive because they are a purer play on the realized month-to-month changes in the CPI. … Their short duration reduces interest-rate risk and the volatility that goes with it.”

A Good Deal Now?
Aside from TIPS’ overall value as an investment, opinions are divided about whether today’s environment warrants moving into them or staying on the sidelines.

A good time to buy TIPS is when inflation is on the horizon but investors have not yet priced that risk into the bonds, says Doty. He thinks that this may be such a time. “A number of inflation measures, such as wage increases or the increase in year-over-year CPI, are well above breakeven rates for TIPS,” he says. “We think investor expectations for inflation will be rising in 2017.”

Nathan Faber, the vice president of investment strategies at Newfound Research, argues that the clearest argument for investing in TIPS ETFs can be made when their breakeven rate is well below the Fed’s target inflation rate. That was the case a few months ago, when the breakeven for the 10-year maturity was around 1.6% and the Fed’s targeted rate for inflation was 2%. At the time, investors weren’t seeing much evidence of inflation and priced the bonds in line with those expectations. Since the November election, renewed expectations for growth and inflation have moved the breakeven rate to almost 2%, which is nearly in line with its long-term average and the Fed target rate.

“There’s still a case for buying TIPS ETFs now,” he says. “But the argument is less compelling than it was a few months ago.”

Mazza believes that trying to time the TIPS market with any accuracy is extraordinarily difficult, and today is no exception. “There is certainly a lot of evidence to support the view that higher prices are returning, including many of the reflationary policies that are being discussed by the new administration. “On the other hand, those policies may never come to fruition.”

Even when TIPS are part of a portfolio, they usually don’t occupy much space. Recently, SSGA’s Global Allocation ETF (GAL) had 5% of its assets in TIPS and 2% in traditional Treasury securities. Faber’s firm uses them only in its most conservatively positioned portfolios, and even then the allocation is usually no more than between 2% and 4% of assets. For more aggressive investors, he believes commodity and precious metals ETFs are better inflation plays.

Shopping Around
Those considering TIPS ETFs have a relatively small universe of 13 ETFs from a half dozen sponsors to choose from, though differences in duration and expenses warrant shopping around.

The most popular funds in the group use a broad-based TIPS ETF index as their bogey. Those include the iShares TIPS Bond ETF (which has an expense ratio of 0.20% and $21 billion in assets under management), the Schwab U.S. TIPS ETF (SCHP, whose expense ratio is 0.07% and whose assets total $1.61 billion) and the SPDR Bloomberg Barclays TIPS (IPE, which has an expense ratio of 0.15% and $785 million in AUM). These have the longest durations and thus carry the most interest rate risk of the inflation-protected group.

Those focusing on the shorter end of the duration spectrum include the Vanguard Short-Term Inflation-Protected Securities ETF (VTIP, which has an expense ratio of 0.08% and $2.91 billion in assets under management), the PIMCO 1-5 Year U.S. TIPS ETF (STPZ, whose expense ratio is 0.20% and whose assets under management are $1.08 billion), the iShares 0-5 Year TIPS Bond ETF (STIP, whose expense ratio is 0.10% and whose AUM is $875 million), and the SPDR Bloomberg Barclays 0-5 Year TIPS ETF (SIPE, which has an expense ratio 0.15% and $5 million in AUM).

The average effective duration for this group is about 2.5 years.

FlexShares offers two target duration TIPS ETFs: the FlexShares iBoxx 3-Year Target Duration TIPS Index Fund (TDTT, which has an expense ratio of 0.20% and $1.9 billion in assets under management), and the FlexShares iBoxx 5-Year Target Duration TIPS Index Fund (TDTF, which has an expense ratio of 0.20% and $676 million in AUM). Both funds tweak portfolio weights to achieve durations of three or five years.