Great inflation hedge unwind sees Tips ETFs lose US$43 Billion

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THE great market inflation hedge of the pandemic era is officially over.

Between cash outflows and capital losses, the combined assets of the 10 largest United States exchange-traded funds (ETFs) that focus on inflation-linked bonds have tumbled from a peak of more than US$99 billion in early 2022 to around US$57 billion. That’s about what they held in late 2020, before the outbreak of the nation’s first major consumer-price surge since the early 1980s.

The pullback underscores how confident investors are that the Federal Reserve has brought inflation back under control. That’s expected to be evident on Tuesday (Feb 13), when economists predict the Labor Department will report that the annual increase in the consumer-price index pulled below 3 per cent for the first time in roughly three years. In June 2022, it was rising at about three times that pace.

The shift in sentiment is not surprising, given that Fed officials share investors’ confidence and anticipate that they will be able to start dialling back interest rates this year to avoid stifling the economy. And ETFs that cater to the investment trend of the moment typically see big pullbacks when investors move on to the next big thing.

“We experienced huge growth post-Covid,” Lindsay Rosner, head of multi-sector fixed income investing at Goldman Sachs Asset Management, said about the Treasury inflation-protected securities, or Tips, flows. “Now, growth feels soft-landing-ish and the need for inflation protection has been lessened. There is less of a demand for this style portfolio allocation.”

But some of the pullback may reflect another fact: The ETFs did not actually fare that well as a safeguard against inflation.

While Tips provide additional payments to make up for the rise in consumer prices, they were not insulated from the impacts of the Fed’s monetary policy tightening. As the central bank pushed up interest rates with unusual speed, their prices tumbled along with other fixed-income securities, more than erasing the extra payouts tied to inflation.

A Bloomberg index tracking the Tips lost a record 12 per cent in 2022. After rebounding 3.9 per cent last year, the benchmark lost 1.2 per cent so far in 2024.

Michael Pond, the head of global inflation-linked research at Barclays Capital, said the losses may have surprised individual investors who flocked to the ETFs, thinking they were a haven. When they lost money instead, many likely decided to pull out.

BlackRock’s US$19 billion iShares Tips ETF – the largest of its kind – attracted a record US$12 billion in 2021, only to see US$14 billion withdrawn in the following two years. The fund lost about 5 per cent over the past three years.

“When Tips had negative returns, many sold them after the fact because they hadn’t performed,” Pond said. BLOOMBERG