Tag Archives: dave-dierking

TIPS ETFs Protect From Inflation Risk, Not Interest Rate Risk

With the Federal Reserve looking to start raising interest rates as soon as next month, investors may be looking for ways to protect their portfolio. While many may look at moving assets into more conservative assets like short term bonds and Treasuries, some will look to Treasury Inflation Protected Securities (TIPS). And that could be a mistake. TIPS work almost just like traditional bonds except that they are indexed to the current rate of inflation. For example, if a $1,000 bond is purchased at par value and the inflation rate is measured at 2%, at the end of the year the principal balance of that bond will be adjusted to $1,020. The higher the inflation rate, the higher the principal balance adjustment. But that’s where the protection ends. Outside of the inflation adjustment, TIPS behave just like any other bond. Shorter term TIPS are generally very conservative investments while longer term TIPS carry a greater degree of volatility. As is the case with any investment that comes with risk, the total value of the investment can potentially lose money over time. All 14 non-leveraged TIPS ETFs that have been around for the last three years have lost money during that time frame. The largest – the iShares TIPS Bond ETF (NYSEARCA: TIP ) – has lost 5.9% during that period. The second largest – the Vanguard Short-Term Inflation-Protected Securities ETF (NASDAQ: VTIP ) – has dropped a more modest 2.4%. As would be expected during a period where bond funds have dropped in value, those on the shorter end of the yield curve have fared the best. Those funds targeting a duration in the 3 year or under range have dropped around 3%. Funds with a slightly longer duration have dropped more with the FlexShares iBoxx 5-Year Target Duration TIPS Index ETF (NYSEARCA: TDTF ) down nearly 5%. ETFs with a long term duration or international TIPS exposure have fared the worst of the bunch. The PIMCO 15+ Year U.S. TIPS Index ETF (NYSEARCA: LTPZ ) has fallen more than 10% over the past three years while the iShares International Inflation-Linked Bond ETF (NYSEARCA: ITIP ) has lost over 16%. All of this is to say that TIPS funds and ETFs provide little protection from the effects of interest rate movements. In economic environments like the current one where inflation still remains below the Federal Reserve’s 2% target, TIPS products can underperform. The Vanguard Total Bond Market ETF (NYSEARCA: BND ) has gained almost 5% over the past three years. Inflation risk isn’t the same as interest rate risk. It’s important that investors know the difference.

VWELX: This 86 Year Old Fund Is Still An Ideal Choice For Retirement

Summary Vanguard Wellington is the first balanced fund in the U.S. having launched in 1929. The fund has ranked in the top 10% of its Morningstar peer group over the past 5-, 10- and 15-year periods. The fund has a beta of 0.65 compared to the S&P 500 while outperforming the index over the long term. Wellington held up remarkably well during the 2000 and 2008 bear markets. In a world where there are literally thousands of funds and ETFs available that cover almost every niche, sector and style available, sometimes it’s the most tried and true investment vehicles that still remain the best choices. In the case of the Vanguard Wellington Fund (MUTF: VWELX ), we’re talking about literally the oldest balanced mutual fund in the country. Launched all the way back in 1929, Wellington looks to maintain a balance of roughly two-thirds of assets in conservative large cap stocks and one-third of assets in a mix of high quality bonds. It’s this type of asset allocation that makes for an ideal core holding in many retirement portfolios. Historically, Wellington has provided exactly what retirement investors should be seeking – above average returns with below average risk. With a current beta of 0.65, you’d expect the fund to return about two-thirds of the SPDR S&P 500 Trust ETF’s (NYSEARCA: SPY ) return but over the past 20+ years that hasn’t been the case. VWELX Total Return Price data by YCharts Looking at the past 2+ decades of history is especially appropriate because it takes into account both bull and bear market environments. The fund has performed about how one would expect – outperforming the S&P 500 in a down market but trailing in an up market. The fund’s risk minimization strategy proved especially effective during the Nasdaq bubble providing a relatively steady market performance given the economic environment. While the chart above doesn’t illustrate Wellington’s performance during the financial crisis particularly well but you can see below how well the fund held up. VWELX Total Return Price data by YCharts While the S&P 500 dropped around 55% from its 2007 peak, Wellington was down about 35%. That’s roughly what you’d expect considering the fund’s 60/40 allocation but the fund’s long term performance has been exceptional. Over the last 10 years, the overall performance of Wellington and the S&P 500 has been almost identical. Using a more apples to apples comparison, Wellington has also outperformed the Vanguard Balanced Index Fund (MUTF: VBINX ) – a fund with a 60/40 stock and bond allocation – during the same 10 year period. Morningstar drops Wellington into the Moderate Target Risk bucket. While the fund has returned 8.2% per year since the fund’s inception, it has consistently ranked at the top of its peer group. Wellington ranks in the top 6% of its peer group over the past 5-year and 10-year periods and ranks in the top 4% in the past 15-year period. It’s this type of risk-managed performance history that retirement investors should be seeking out. Retirement income investors will also appreciate the fund’s 2.43% yield. The fund has a few dividend champions among its equity holdings and the bond holdings are almost entirely high quality corporate and Treasury securities ensuring that the fund’s dividend is secure and reliable. Conclusion I’m a firm believer that in the case of most retirement investors, simpler is better. Sophisticated investors may feel comfortable building a more complex portfolio using stock, sector ETFs, etc. but for those who want an all-in-one long term holding that they can just establish and forget about, it’s hard to imagine someone doing much better than Vanguard Wellington. The combination of strong long term performance, risk minimization and low costs make this an ideal core retirement holding even if it’s not as exciting as some of the newer niche products hitting the market today.

High Yields Generated From Surprising ETFs

Private equity ETFs have around $500 million in total assets. Some yield as much as 8%. Private equity ETFs have lagged the broader market over the past 5 years. Private equity is often viewed as an investment reserved for the ultra-rich but, thanks to the ETF issuers like PowerShares, investment in small privately held companies is increasingly available to the smaller investor too. The PowerShares Listed Private Equity Portfolio ETF (NYSEARCA: PSP ) doesn’t invest directly in privately held companies but does invest in business development and venture capital firms that often invest in and attempt to bring these companies public. This ETF and the ProShares Global Listed Private Equity ETF (BATS: PEX ) are the only ones listed by the ETF Database that target private equity as an investment objective. The ProShares ETF currently has roughly $436 million in assets under management. While private equity is likely missing from many investors’ portfolios, it’s an asset class that comes with high risk, high return potential and, perhaps surprisingly, high yields. The inherent riskiness that comes with an investment in boom-or-bust privately held small companies is coupled with the fact that this ETF maintains a large allocation to overseas investments, including emerging markets in both Europe and Asia. The Listed Private Equity ETF is also fairly sector concentrated with over half of assets currently in financials, making this ETF vulnerable to changes in interest rates and broad economic activity. An expense ratio of over 2% makes this a costly investment that will eat directly into investor returns. One of the great benefits of this product, however, is its yield. This fund currently sports a trailing 12-month dividend yield of 8%. It’s not necessarily a great product for those looking for regular predictable income from their portfolios as the dividends are very cyclical and can vary significantly on a quarter to quarter basis. This dividend yield has been the saving grace for this ETF lately. The share price has been virtually flat over the past 5-year period, but the big yield has pushed the fund to a 44% total return over the past 5 years. That works out to an average annual return of about 7% per year. That number trails the S&P 500’s average annual return of 11%.