Rising Rates? Buy These Inflation-Protected Securities

The recent sharp rise in rates, particularly seen in the 10-year Treasury, has caught the market's attention. Indeed, several leading advisors and contributors to MoneyShow.com feel it is now appropriate for conservative investors to consider hedges that protect portfolios against future inflation and rising rates. Genia Turanova, Curzio Research's Unlimited Income After a year mired in COVID misery, the economy is returning to normal. Stock prices and commodities are flying -- and inflation expectations are rising. Despite what the Fed wants us to believe, inflation is coming. One measure of inflation expectations, based on a 10-year breakeven rate, was recently as high as 2.22% -- a level last observed in 2014. Commodities are soaring, too. Meanwhile, the Fed has committed to keeping interest rates steady for longer. Translation: Central bankers are willing to get the economy going at the expense of inflation. Thanks to that, plus the enormous stimulus bill, the economy could overheat... and the Fed won't do much. Inflation can get out of control fast. In that case, investors will benefit from an inflation hedge. One such hedge is a special class of U.S. Treasury bonds, designed to deliver interest income that keeps up with the level of inflation. These are called Treasury inflation protected securities -- or TIPS. The principal of a TIPS bond increases with inflation and decreases with deflation (as measured by the CPI). At maturity, a TIPS bond will pay the greater of either the adjusted principal or the original principal. TIPS pay interest twice a year at a fixed rate. But because the rate is applied to the adjusted principal, interest payments will also rise with inflation and fall with deflation. Thus, when you're worried about inflation, they're a better alternative to holding cash. First created in 1997, when inflationary concerns reemerged, TIPS are now offered in 5-, 10-, and 30-year maturities. Over the past decade, TIPS delivered a 4% average return (price appreciation plus dividend) -- beating inflation if not the overall market. Overall, TIPS are one of a few fixed-income investments that offer some inflation protection. And it's quite easy to invest in TIPS via exchange-traded funds (ETFs). My favorite ETF in this category is Schwab U.S. TIPS ETF , which holds more than 40 different bonds with a total value of more than $15.5 billion. This fund is liquid and among the cheapest compared to similar funds -- it only costs 0.05% (the expense ratio) a year to own. In other words, you'll pay 0.05% of the dollar value invested in the fund annually to service it (holding and, as needed, buying and selling of the individual bonds). SCHP is a much better bargain than the large competing fund, iShares TIPS ETF , which has a substantially identical portfolio but a much higher expense ratio at 0.19%. Because the yield on TIPS is related to the yield on Treasuries, SCHP also generates a decent enough yield of about 1.1% -- a yield set to rise if the CPI moves higher. Holding 43 TIPS securities with various maturities, SCHP is a great hedge against the damage inflation can wreak on the purchasing power of your assets. We recommend Schwab US TIPS ETF for portfolio security and inflation protection. Don't pay more than $62.50 per share. Bob Carlson, Retirement Watch We've anticipated higher inflation for a couple of years by moving portions of our portfolios into gold and Treasury Inflation-Protected Securities, known as TIPS. The Federal Reserve and other central banks have made no secret of their intention to encourage higher inflation. The Fed won't tighten monetary policy until U.S. inflation has been solidly above 2% for a sustained period. U.S. inflation was steadily creeping higher before the pandemic and started a new path higher last summer. I anticipate inflation taking a bumpy path over the next couple of years to a higher level than the markets expect. One fund that hasn't done as well recently is iShares Gold Trust . Gold soared for most of the first eight months of 2020 but has fallen into a lower trading range since peaking last August. The climb during the summer of 2020 was excessive, fueled by a combination of excess liquidity from central banks and a flight to safety. Still, I expect more gains in gold as the world's central banks continue their expansionary monetary policies and many governments create fiscal stimulus. It won't be a straight line up as it was in the summer of 2020, but the price of gold should rise steadily higher. SPDR Portfolio TIPS is another inflation hedge and risk-balancer in our model retirement portfolio. The fund invests in TIPS. TIPS are U.S. government-issued bonds that have their principal value adjusted higher each year with increases in the Consumer Price Index, but not with any declines. That inflation indexing also increases the interest payments as the principal value increases. Jim Woods, The Deep Woods The SPDR SSgA Multi-Asset Real Return ETF is an actively managed fund that attempts to hedge against inflation. The fund achieves this goal by investing in other funds with exposure to real estate, commodities, Treasury Inflation-Protected Securities (TIPS) and natural resources companies. RLY seeks to achieve real return consisting of capital appreciation and current income. The fund invests in exchange-traded funds registered under the Investment Company Act of 1940, as amended, to track the performance of a market index, exchange traded commodity trusts and exchange-traded notes (ETNs). The fund's portfolio may invest in certain exchanged-traded products that pay fees to the fund adviser and its affiliates for management, marketing or other services. Thye Multi-Asset Real Return ETF provides exposure to inflation-protected securities issued domestically and internationally, domestic and international real estate securities, commodities and publicly traded companies in natural resources and/or commodity businesses. These companies may include agriculture, energy, metals and mining companies. The fund's investment process relies on a proprietary quantitative model, as well as the adviser's fundamental views regarding factors that may not be captured by the quantitative model. While a low fee and strong investor interest help to make the case for RLY, performance has been somewhat disappointing in recent years. Over the past year, RLY was hit hard by the pandemic, but quickly recovered and climbed to new highs. However, please conduct your own due diligence in deciding whether or not this fund fits your own individual portfolio and investing goals. Unlike some of its peers, RLY has attracted sufficient assets and liquidity since its April 2012 launch to signal long-term viability. Investors might be enticed by the relatively low fee, or perhaps they like RLY's value proposition returns above the rate of inflation. The fund's allocations -- made easier to grasp by an ETF-of-ETFs structure -- are consistent with this goal. The fund holds TIPS, but it also has direct and indirect exposure to commodities, including a huge stake in the SPDR S&P Global Natural Resources ETF and real estate exposure via REIT-related ETFs. Brett Owens, Contrarian Outlook Higher long-term rates are, generally speaking, bearish for bond prices. Consider a popular safe ETF pick that's been crushed by this rally. The iShares 20+ Year Treasury Bond ETF has crashed 17% over the past six months. Seventeen percent! Thoughtful readers have asked if it's time to buy floating rate bonds. It's a bit early, but it's better than holding Treasuries. The iShares Floating Rate Bond ETF and SPDR Bloomberg Barclays Inverse Grade Floating Rate ETF at least haven't lost money. Moving past the hype of ETF-land, we find better yields and returns in closed-end funds (CEFs). Fixed and floating rate CEFs alike are doing fine. Their yields are so much higher than the 10-year rate that Treasury drama is a non-event. Let's consider the net asset values (NAVs) of two of my favorite floating rate CEFs -- BlackRock Floating Rate Strategy and Eaton Vance Floating Rate Income . They have enjoyed NAV gains of 5% and 7% over the last six months as the 10-year rate has risen. The coupons on their bonds have ticked up alongside the 10-year yield, so their portfolios have become more valuable. When it comes to CEFs, we look at NAVs rather than prices. The CEF sector is a backwater of hidden gems where prices can often dip below their NAVs (or intrinsic values, market value of their bonds minus any debt). When we measure the performance of a portfolio, we get a way better reading by using NAV than the emotion-laden price. We also need to keep in mind that these NAV gains are net of the dividends paid. FRA and ETF yield 6.2% and 5.4%, respectively, which dwarf TLT's sad 1.8% dividend and FLOT's pathetic 0.2% attempt. Not only do FRA and ETF pay more but they are heading in the right direction. BlackRock Floating Rate Strategy and Eaton Vance Floating Rate Income trade at discounts, too. But let's remember that markets don't move in straight lines. When everyone is sure that something will happen (that rates will keep rising, for example), the next move is often in the opposite direction. The 10-year yield has run up rapidly and is due for a breather -- and we should use any breather in the rate rally as an opportunity to add floating rate plays to our portfolio.

Rising Rates? Buy These Inflation-Protected Securities

Inflation can get out of control fast. In that case, investors will benefit from an inflation hedge.

Columnist Conversation

Jobs Report Reaction: Incredibly Strong, But Questions to Ask

This Weekend on Real Money

AMD Second-Quarter Earnings Live Blog

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.