Mixed Record Of Inflation Hedges

October 06, 2014

TIPS – Inflation Protected Bonds

Missing from the chart—because of their short history—are Treasury inflation-protected securities, or TIPS. These are bonds issued by the U.S. Treasury whose principal—that is, their final payments—increase with inflation as measured by the CPI. By law, they will hold their value no matter the level of inflation. Somewhat counterintuitively, however, there is not strong correlation between TIPS prices and inflation.

Columbia professor Andrew Ang points out in his book, “Asset Management: A Systematic Approach to Factor Investing,” that the problem with TIPS as an addition to a portfolio is that they are dependent upon real yields.

“As inflation increases, real yields tend to fall. As a result, a TIPS portfolio of new and seasoned bonds of different maturities tends to decline in value when inflation rises,” Ang writes.

You can take measure of this phenomenon by observing that the total returns of many TIPS are lower in the past two years as negative real rates slowly get worked out of the system as the economy slowly recovers. My conclusion is that adding a bit of TIPS to a portfolio to protect it from inflation, while intuitive, won’t work that well.

TIPS are well represented in the ETF world by funds like the iShares TIPS Bond ETF (TIP | A-99) and the FlexShares iBoxx 3-Year Target Duration TIPS ETF (TDTT | A-46).

Treasury Bills

Given the damage inflation does to 10-year bonds and the disappointing performance of inflation-protected bonds, we might be inclined to forget about the fixed-income market altogether. But that would be a mistake, as short-term fixed-income instruments offer some of the best protection against inflation.

While the prices of T-bills decline as inflation surprises materialize, the pain is short lived, as the U.S. Treasury offers new bills in weekly auctions at new higher yields. In other words, you’re only behind the curve for a limited period of time.

Given that U.S. Treasury bills are basically the definition of “risk free,” our best advice to those worried about inflation is to reduce long-duration assets such as conventional bonds or stocks, and shift that capital into bills, such as those included in funds such as the iShares Short Treasury Bond ETF (SHV | A-97) or the SPDR Barclays 1-3 Month T-Bill ETF (BIL | A-62) for as long as the fear lasts. The forgone returns should be thought of as the price one is paying for insurance.


The GSCI has had good returns over its life, and it does have a fairly strong correlation with rates of inflation. That said, I feel investors need to be well educated and selective about commodity investments.

About half the commodity returns in the GSCI over the long term are due to the T-bill returns incorporated in the futures positions that make up the index, not from the unique characteristics of commodities. Furthermore, the composition of the index in the 1970s was mainly agricultural commodities such as wheat and corn, not the overwhelming majority of energy such as we see today.

While you could argue that, together with the good inflation characteristics of bills we discussed above, commodities have a chance of producing a good return in inflationary times, the high volatility of the market requires constant monitoring, and I think it should mainly be used by professional—or at least extremely diligent—investors.

For commodity investing, at Astor, we prefer the PowerShares DB funds because of their awareness of some subtleties in taking positions, so if I wanted to express an inflation theme with a futures-based commodity ETF, I would likely choose the multicommodity-focused PowerShares DB Commodity Tracking Fund (DBC | B-86) or the energy-focused PowerShares DB Energy Fund (DBE | C-100).


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