0

I abbreviate: inflation-protected bonds = IPB
(I choose this term because I don't want to limit this question to US TIPS);
yield to maturity = YTM.

Whenever deciding to invest in a bond ETF, should you always invest in one that features at least some IPB?
I refer NOT to ETFs that hold exclusively IPB. Instead, I ask about ETFs that hold:
- IPB (at the minimum)
- and/or only other bonds with YTMs that exceed the IPBs' YTM.
Call these ETFs: IPB as Safety Net. Does this etfdb.com list show some IPB as Safety Net?

Here's my guess. Suppose you invest in an IPB as Safety Net. The worst outcome is: you gain nothing, but at least you are protected against inflation. Right?
Whereas for any other ETF without IPB, the worst outcome is: if inflation surpasses the YTM, then you'll be always worse off, compared with the IPB as Safety Net.

2

Despite the name, IPBs as you call them are not very good inflation protection. That is why many that work in the field will call them Inflation-Linked Bonds (ILBs) and avoid the word "protection".

The reason is that inflation-linked part of the ILBs only applies to the principal (the amount that you are paid at the end) and not the interest. For longer dated bonds, like many ILBs, the many years of interest can be as or more important than the principal remaining even at low current rates. The big issue is that when inflation spikes, interest rates also tend to spike. So ILBs that you are stuck with from low rates times will be worth much less than newer bonds at the higher rates, even if you get some of the value back from higher principal amounts. For a large inflation spikes, ILBs will perform somewhat better than equivalent non-ILB bonds, but neither would qualify as protection.

Interestingly, stocks can generally be better inflation protection in the long term as you own part of an actual company whose value will generally rise along with inflation. Though extreme inflation can be troublesome for equities. Foreign companies in particular (and sometimes foreign bonds) can be good inflation protection if the inflation is in your currency.

Commodities can be good inflation protection as well, though they can be more complicated and since they don't have a yield aren't generally great for long-term investment.

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.