TIPS Still a Good Inflation Hedge for Some Investors: Schwab Panel

News June 02, 2022 at 02:59 PM
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Treasury inflation-protected securities continue to be a good buffer against long-term inflation for at least some investors, D.J. Tierney, senior client portfolio strategist at Schwab Asset Management, said Wednesday at the Wealth Management EDGE conference in Hollywood, Florida.

During the panel session "Are TIPS a Good Inflation Hedge?" Tierney and others gave their takes on how portfolios should be positioned for high inflation. They didn't all agree on the effectiveness of TIPS investing right now.

Asked by an attendee how investors can get simple exposure to TIPS, which are a type of U.S. Treasury security whose principal value is indexed to the rate of inflation, Tierney noted that one way is through the Schwab U.S. TIPS ETF.

That exchange-traded fund's goal is to track as closely as possible, before fees and expenses, the total return of an index made up of inflation-protected U.S. Treasury securities.

Tierney called TIPS ETFs a "really elegant solution for a lot of fixed income allocations," noting they're "inexpensive, tax-efficient."

"If you're just buying" a similar index, "you're missing" the full benefit of the hedging strategy, he told attendees.

ETFs and Fixed Income

"If you're not managing your fixed income allocation through ETFs, that's a huge miss," Michael Contopoulos, director of fixed income at Richard Bernstein Advisors, told attendees.

After all, he said: "If you're using a traditional long mutual fund manager, buying individual bonds, [and] you have massive liquidity issues, the bond market has becomes less and less liquid. It's not tax efficient.

"So I think using ETFs to manage a fixed income portfolio" makes sense, although not necessarily TIPS ETFs."

There are a few "fixed income concepts that have done well over the last 6, 12, 18, 24 months and you can get exposure to them through ETFs," he pointed out. "That's what we do at RPA. We basically only use ETFs…. And we actually owned an ETF last year. Eighty-five percent of that ETF was Schwab's TIPS ETF."

But TIPS ETFs are not necessarily a great option right now for investors in general, according to Contopoulos.

As Schwab itself concedes at its website, if inflation rises sharply, TIPS may not perform well over the short term. Along with inflation adjustments, "TIPS performance over the short run is also driven by price appreciation or depreciation depending on any change in the TIPS' yields," according to Schwab.

If yields increase enough where the security's price declines enough to offset the inflation adjustment, total returns may be negative, says Schwab. Similarly, if yields decline further and prices rise in the short run, total returns could be strong given both price appreciation and the inflation adjustment, according to the firm.

"With yields so low, however, we do see a risk in yields moving modestly higher into 2022, which may limit the total return potential for TIPS investments," Schwab says. Because of that, the firm said it stopped short of calling TIPS a good inflation hedge, especially over the short run. "Over the long run, however, TIPS are one of the most straightforward ways to protect against inflation," it says.

Asked what would get him back to supporting TIPS as an investment strategy this year, Contopoulos said: "For me, it would be that the Fed went back to transitory language that seemed as though, for whatever reason … the 10-year [Treasury] wasn't going to go higher… and it was suggested that the 10-year had topped out but that you're entering into some sort of stagflationary environment where growth remained relatively low."

Along with that, if "inflation remained elevated, that would be a really good reason to buy TIPS," he added.

But "I don't think we're close to stagflation personally. Yet," Contopoulos said with a laugh, conceding: "We could be. We've got to keep an eye on it and track the data but I don't think we're there. But that would be the scenario."

A 'Tremendous Opportunity'

Meanwhile, "there's tremendous opportunity, I think, in inflationary assets because … I think we're sort of at the beginning of a paradigm shift — one that likely yields, over the long term, higher inflation," according to Contopoulos.

"You may get some quirky inflation numbers that [include] negative inflation. We get disinflation," he said. But he predicted that, on a medium- to long-term basis, "we think you're in a higher inflationary environment where there's tremendous opportunity, particularly [on] the resources side, and you can get that exposure through very easy traditional asset classes like U.S. energy."

Or through commodity-exposed countries like Australia, Canada and the U.K., he added, calling that a "very overlooked area of the market."

Baby Boomers

There may, meanwhile, be a challenge ahead for baby boomers in particular, according to Tierney. "We look at the demographics of the baby boomers — they're the largest constituent of investors still — and if we look at their average portfolios, they're hugely overweight in equities," he said.

This is "a generation that got very comfortable with equities because it's done well for their whole investing lives but they're really putting themselves at risk for what should be a 30- to 40-, 30- to 35-year retirement," he warned. "They've got too much equity exposure and they're vulnerable to long periods of drawdowns."

He added: "If you remember nothing else from this session … we do have three and a half, four and a half percent bonds out there now. And so it's not a bad time to reengage with your clients and talk about fixed income."

And, when you do that, he suggested discussing TIPS with them, noting "there's really easy ways to get TIPS exposure."

(Pictured: D.J. Tierney, senior client portfolio strategist at Schwab Asset Management; Photo by Jeff Berman)

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