The Bloomberg Barclays US Government Inflation-Linked Bond Index measures the performance of the US TIPS market. The index includes all capital-indexed US government bonds with either fixed or zero notional coupon, a remaining maturity of at least one year, and a minimum outstanding of USD 500 million. In practice, the index basket is generally made up of all existing TIPS, except those with a remaining maturity of less than one year.
The index is calculated daily using midmarket real prices provided by Barclays market makers at the local market close. The index is rebalanced on the last calendar day of each month. Bonds are weighted by their market capitalisation value. Index holdings are valued at face value rather than on an inflation-adjusted basis. Coupon income received intramonth is invested at one-month US-dollar Libor minus 15 basis points and reinvested into the index at rebalancing.
Go To Top
The annual ongoing charge for this ETF is 0.25% for the unhedged version and 0.27% for the euro- and pound sterling-hedged share classes. This comes across as expensive relative to passive peers in the category. In fact, investors can now get passive exposure to this market for as low as 0.09%.
However, the ETF's tracking difference has routinely come in significantly below the ongoing charge of 0.25%. The substantial revenues obtained via securities lending are the key contributing factor.
Additional costs potentially borne by investors and not included in the ongoing charge include bid/offer spreads and brokerage fees when buy/sell orders are placed for ETF shares. There are also rebalancing costs whenever the index changes composition.
Go To Top
IShares uses physical replication. The limited size of the US TIPS market allows iShares to use full replication to construct the fund. However, there may be slight differences in the statistical weights of individual constituents between fund and index. As such, iShares prefers to describe the replication methodology as sampling.
The ETF faithfully replicates the index's statistical split between short/medium- and long-dated maturities, which in turn is reflective of the inflation-linked bond issuance strategy pursued by the US Treasury. The ETF does not distribute dividends.
IShares engages in securities lending with the holdings of the ETF. BlackRock acts as investment manager on behalf of iShares. The ETF can lend out up to 100% of net asset value. The average on loan for this ETF in the 12 months to the end of June 2018 was 89%, for an annualised return of 12 basis points. Lending operations are backed by taking UCITS-approved collateral greater than the loan value and by revaluing loans and collateral daily. The collateral is held in a ringfenced account by a third-party custodian. The degree of overcollateralisation is a function of the assets provided as collateral but typically ranges from 102.5% to 112%. Lending revenue is split 62.5/37.5 between the ETF and BlackRock, respectively.
Go To Top
IShares $ TIPS ETF offers investors exposure to US inflation-linked government bonds, commonly known as Treasury Inflation-Protected Securities, or TIPS. This is a classic buy-and-hold strategy for US-centric investment portfolios, which works well in passive form. From the point of view of European investors, it would probably be more of a tactical bet.
The ETF tracks an index that comprehensively captures the available opportunity set of what is a small and liquid bond market. The fund has delivered risk-adjusted returns consistently above the Morningstar Category median, typically ranking in the upper areas of the first quartile. Performance over isolated periods will be determined by the vagaries of US monetary policy. The fund has mid- to high duration, and so we would expect it to lag a bit at times of rising interest rates but outperform more clearly when the cycle turns. In any case, this is a market where there seems to be little scope to add value over the benchmark other than with duration calls, but they may wash out over time.
In terms of the management of the fund, the exchange-traded fund makes heavy use of securities lending. This practice generates sizable revenues, helping the ETF to routinely deliver a tracking difference well below an ongoing charge of 0.25% for the unhedged version (0.27% for the euro- and pound sterling-hedged share classes), which is high relative to passive alternatives.
In our view, iShares' securities-lending programme is well managed and tightly controlled for counterparty risk, including full indemnification against borrower default. However, some investors may feel unnerved at the elevated levels of this ETF's lending.
Overall, despite potential misgivings about the ETF’s heavy use of securities lending to lower the annual holding cost, we acknowledge that a passive approach to the US TIPS market is likely to work well over the long term. The fund retains a Morningstar Analyst Rating of Silver.
Go To Top
The US economy's domestic performance remains on a strong footing. Private consumption and business investment have improved, and the housing market has strengthened. Labour market conditions have also shown consistent positive signs, with the jobless rate down to multidecade lows.
Inflationary pressures, which had remained largely contained, are now showing signs of building up somewhat. Broad CPI has steadily risen above 2.0% through 2018, although the core CPI measure, which excludes energy prices and is the Fed's preferred measure of inflation, has lagged somewhat and remains broadly in line with the Fed's price stability target of 2.0%.
Overall, compared with other developed economies, the inflationary outlook in the United States may be subject to more upside risks over the long term. In particular, increasing tightness in labour market conditions could eventually feed into wage-related price pressures.
The US Federal Reserve kicked off the process of policy normalisation in December 2015, but it has proceeded cautiously. As of this writing, interest rates remain below historical standards. However, the path remains firmly biased to the upside, and the risk is for an acceleration in the delivery of hikes should the economy show signs of overheating.
Go To Top
IShares was quick off the mark in providing European investors with ETFs tracking the US TIPS market, managing to capture the bulk of market share in the process. As of this review, iShares $ TIPS ETF remains the market leader, as measured in assets under management, but it has lost ground to cheaper alternatives.
The cheapest available ETF option is Lyxor US TIPS at 0.09%. It is also physically replicated and tracks the same index as the iShares fund. SPDR Bloomberg Barclays US TIPS ETF has also managed to build up a decent level of assets. It is physically replicated, tracks the same index as iShares, and charges 0.17%.
IShares also offers an ETF covering the 0 to five-year maturity segment of the TIPS market for a much lower 0.10% (unhedged) or 0.12% (hedged to the pound sterling). UBS Bloomberg Barclays TIPS 1-10 ETF is also a popular choice. It charges 0.15% (unhedged) or 0.20% (hedged to the euro, pound sterling, and Swiss franc).
Go To Top