This ETF designed to protect against inflation is attracting inflows as price pressures persist

Signs of moderating inflation haven’t kept some investors from worrying that price pressures will stick around at elevated levels. 

“The market still has rose-colored glasses on,” said Doug Fincher, a portfolio manager at hedge-fund firm Ionic Capital Management, in a phone interview. “You can have inflation in a mild recession.”

The iShares TIPS Bond ETF TIP, which tracks an index of Treasury inflation-protected securities, has attracted around $244 million of inflows over the past week, according to FactSet data as of Wednesday. Investors have poured $630 million into the fund over the past month, although so far this year it has still seen outflows of $604 million, the data show.

If inflation is the “boogeyman” for traditional asset classes, then investors may want some direct exposure to it in their portfolios, said Fincher. In his view, “inflation swaps are the best pure way to invest in inflation.”

In late June, Ionic Capital launched the Ionic Inflation Protection ETF CPII, which invests in inflation swaps, swaptions and Treasury inflation-protected securities, or TIPS. The fund has seen a 0.7% total return since June 30 through Wednesday, compared with a 0.5% gain for the iShares Core U.S. Aggregate Bond ETF AGG over the same period, FactSet data show.

Meanwhile, the iShares TIPS Bond ETF TIP, with around $23 billion of assets under management, has gained 4% this year on a total return basis through Wednesday, according to FactSet data. That slightly surpasses the 3.8% gain of the iShares Core U.S. Aggregate Bond ETF over the same period.

Both bonds and stocks broadly sold off last year as the Fed aggressively raised interest rates to tame hot inflation.

The iShares Core U.S. Aggregate Bond ETF lost 13% on a total return basis in 2022, the fund’s worst year on record since it began trading in 2003, according to FactSet data. And the SPDR S&P 500 ETF Trust SPY, which launched in 1993, sank 18.2% on a total return basis for its worst year since 2008.

U.S. inflation has remained elevated in 2023 despite easing from last year’s peak.

Minutes from the Federal Reserve’s policy meeting last month, which were released Wednesday, showed Fed officials voted unanimously to raise rates in March. The Fed’s staff projected “a mild recession starting later this year with a recovery over the subsequent two years,” according to the minutes.

The Bureau of Labor Statistics said Wednesday the consumer-price index, or CPI, rose 0.1% in March for a year-over-year rate of 5%. The headline rate was down from a 6% rise in the 12 months through February. But March’s core inflation, which excludes energy and food prices, was up 5.6% from a year ago, slightly higher than the year-over-year rate seen in February. 

“It’s good to see the headline figure coming down,” but the pace is still too slow “to justify this pivot that the market keeps pricing in,” said Tim Urbanowicz, head of research and investment strategy at Innovator ETFs, in a phone interview.

The market is largely expecting the Fed to continue raising its benchmark rate at its policy meeting in early May, but fed-funds futures point to potential rate cuts as soon as this summer.

On Thursday afternoon, Fed-funds traders saw a 68.8% chance of a quarter-point rate increase at the Fed’s May meeting, according to the CME FedWatch Tool, at last check. They were also largely betting on a pause in rate hikes in June, and a potential cut at the Fed’s July meeting.

“Yes, inflation is moderating. We all know that,” John Davi, chief executive officer and chief investment officers of Astoria Portfolio Advisors, tweeted Wednesday. “The key is that commodity equities, natural resources stocks and other inflation linked assets are trading at bargain basement prices,” he wrote, citing price-to-earnings ratios of 8-9.

Inflation-linked assets are a “good hedge” for portfolios that are “back to being overweight technology, defensives, and high quality/long duration assets,” according to his tweets on Wednesday. He said he doubted these “winners of the past decade” will repeat in the next three to five years.

The AXS Astoria Inflation Sensitive ETF PPI, an actively managed fund that may provide exposure to equities, commodities and TIPs, had a 4% total return last year, even as the Fed’s aggressive rate-hiking campaign in 2022 to bring down high inflation led to deep losses for stocks and bonds broadly, according to FactSet data. So far this year, the ETF has eked out a total return of 0.9% through Wednesday.

Meanwhile, the Ionic Inflation Protection ETF was down 0.2% this year on a total return basis through Wednesday, FactSet data show. Five-year inflation swaps are the core holding of the fund, according to Fincher. The fund also owns swaptions that are “essentially a call option on higher rates,” he said, as well as “short-dated” TIPS.

Meanwhile, the U.S. stock market has climbed in 2023, with the S&P 500 index rising around 8% through Thursday. The valuation of the S&P 500 SPX is expensive, as it has been trading around 18 to 19 times earnings, according to Urbanowicz. 

As long as inflation remains high, or isn’t falling significantly, “there’s not going to be a lot of upside in the equity market, especially when we’re already trading at 18 – 19 times earnings,” said Urbanowicz. “We think that’s pretty rich given that backdrop that we’re dealing with,” he said, adding that he’s worried about inflation persisting in services in particular, as well as a slowing economy.

The Innovator U.S. Equity Power Buffer ETF PAPR has seen recent inflows, according to Urbanowicz. In his view, uncertainty around inflation and recession fears have helped fuel the interest into the fund, which is designed to buffer losses and cap gains on the S&P 500.

 

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