STPZ - Short Or Long TIPS ETFs Are A Bust

2023-08-02 05:30:00 ET

Summary

• US inflation rates reached 40-year highs in June 2022, prompting investors to move into Treasury Inflation Protected Securities (TIPS) funds.
• The article reviews two such ETFs: PIMCO 1-5 Year U.S. TIPS Index ETF and PIMCO 15+ Year U.S. TIPS Index ETF.  TIPS are also compared against other inflation hedges.
• With High-Yield Corporates outperforming TIPS since 2001 and stocks providing higher returns long-term, I give both STPZ and LTPZ Sell ratings.

(This article was co-produced with Hoya Capital Real Estate )

Introduction

After years of keeping the “inflation genie” in the bottle, government responses to COVID, first closing economies down then opening up the floodgates on spending and free cash drove US inflation rates to 40 year highs, peaking at over 9% in June of 2022. Central banks fought back by raising interest rates, which hurt existing debt instruments.

At the time investors jumped into funds that invest in TIPS, Treasury Inflation Protected Securities, though that is not currently true.

So when inflation was peaking, investors were leaving TIPS funds! This article reviews two such ETFs to examine how investors did against this decade-high inflation scourge. The two I picked are:

• PIMCO 1-5 Year U.S. TIPS Index ETF ( STPZ )
• PIMCO 15+ Year U.S. TIPS Index ETF ( LTPZ )

Since the purpose is keeping investors whole after inflation, the next chart shows what the returns needed to be to cover inflation (but not taxes).

PIMCO 1-5 Year U.S. TIPS Index review

Seeking Alpha describes this ETF as:

The fund invests in Treasury Inflation-Protected Securities with a maturity of at least 1 year and less than 5 years. It seeks to track the performance of the ICE BofA 1-5 Year US Inflation-Linked Treasury Index . The ETF started in 2009.

Source: seekingalpha.com STPZ

STPZ has $781m in AUM and comes with 20bps in fees. The TTM Yield is 3.1%. PIMCO lists the distribution yield at 2.5%, the YTM at 4.8%.

The ICE BofA 1-5 Year US Inflation-Linked Treasury Index is a subset of ICE BofA US Inflation-Linked Treasury Index including all securities with a remaining term to final maturity less than 5 years.

STPZ holdings review

Since the mandate is 0-5, I assume all the 8.78% in the 5-10 is at the 5-year level. PIMCO also provides how the Effective Duration is affected by market conditions and the yield curve.

PIMCO's site provides the above but doesn't show the holdings, Seeking Alpha does.

STPZ distributions review

Payouts are more erratic than the change in the inflation rate. The yield was matching inflation at a good rate until it spiked in 2022, with it trailing until again coming close thanks to inflation declining, not income climbing.

Seeking Alpha gives SPTZ an "A-" grade for dividends.

PIMCO 15+ Year U.S. TIPS Index ETF review

Seeking Alpha describes this ETF as:

The ETF primarily invests in U.S. dollar denominated Treasury Inflation-Protected Securities with a maturity of at least 15 years. The fund seeks to track the performance of the ICE BofA 15+ Year US Inflation-Linked Treasury Index . LPTZ started in 2009.

Source: seekingalpha.com LPTZ

LTPZ has $644m in AUM and comes with 20bps in fees. The TTM Yield is 5.25%. PIMCO lists the distribution yield at 6.9%, the YTM at 4.2%.

The ICE BofA 15+ Year US Inflation-Linked Treasury Index is a subset of ICE BofA US Inflation-Linked Treasury Index including all securities with a remaining term to final maturity greater than or equal to 15 years.

LPTZ holdings review

As with my assumption about STPZ, here all the 10-20 maturity is assumed to be over 15 years to match the mandate. The duration data is as such.

Along with the higher yield, this ETF should provide a higher total return once interest rates start down at a 6X ratio based on the different durations. Here are the top holdings.

With less positions, LTPZ has a higher concentration in their Top 10 holdings at over 91%.

LPTZ distributions review

To no surprise, the payouts fluctuate in a similar pattern as the other TIPS ETF. As with other bonds, ones with a longer maturity yield more, thus LTPZ's yield matched up better with inflation rates.

In both charts, note that the yield peaked about four months after inflation did. Here, the ETF was also given an "A-" grade.

Performance review

As expected, LTPZ responded to the movement in interests rates, dropping as the FOMC reacted to COVID and then climbing as the FOMC tackled the inflation caused by the government's response to COVID. SPTZ's ride was smoother but less beneficial to investors. The next dataset shows the risk statistics for both, with results as expected based on duration differences.

One last chart shows the income generation difference.

Stocks or gold vs. inflation and TIPS

Using different sites, I pulled together the following data points that show that the total US stock market might be best asset class to fight inflation. I also included Gold, a traditional “inflation hedge” asset.

*data starts in 2001

Since 1972, which covers high/low inflation periods, stocks were the best investment. That said, during the last long and high inflationary period, stocks failed but gold outpaced inflation. The same occurred during what is referred to as the “lost decade”, when stocks had a negative return: TIPS also beat stocks and inflation (dates aligned).

Portfolio strategy

We see that TIPS did not beat inflation consistently, especially when bond prices drop as interest rates rise; that would be a tough challenge, but let's look at them thru a different lens. How did they do against investment-grade and "junk" bonds of the same duration?

STPZ came in third over the past year when inflation was peaking and rates climbing; their 5-years results are much better compared to the other ETFs. TIPZ has been the poorest choice except for the YTD results.

While I do not hold any TIPS or iBond ETFs, I do have about 1% of my portfolio in direct ownership of I-Bonds in my TreasuryDirect account, some of which date back to 1993 when the fixed rate was 1.4%. With limits on how much one can purchase each year, building a large allocation can take some time but this is a second means of adding inflation-adjusted bonds to one's portfolio. The big downside is rules around lost interest, and it can take weeks to get the funds out of your TD account.

Final thoughts

In my view, TIPS ETFs match up best when inflation is low and steady, with stocks poised for limited gains, like just after the 1999-2000 Tech bubble burst. There are several "market mavens" predicting another decade of subpar equity results but putting the "inflation genie" back in the bottle is proving challenging. How much interest rates can drop is dependent on both FOMC actions and investors demand for the amounting level of US government debt.

With High-Yield Corporates outperforming TIPS since 2001, I give both STPZ and LTPZ a Sell rating as they are not meeting their goal as I read the results and taking on default risk has provided better returns.

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