PIMCO 1-5 Year U.S. TIPS Index ETF (STPZ): Positive 1-Yr Return

(This article was co-produced with Hoya Capital Real Estate)

Introduction

Maybe it is the first sign that the Fed policy of quicker interest rate hikes are taming inflation as some commodity prices fell during the second quarter. Of course, this could be just the calming down about the long-term effects that the war in Ukraine might have, especially on oil, natural gas, and several grains. Time will tell.

One way small investors have address inflation is by investing in I-bonds, which currently yield 9.62% or more, depending when each I-bond was initially purchased. Unfortunately, there are restrictions that cap how much each investor can buy each year ($10,000 directly, $5000 via Federal tax refunds). For greater amounts and more control over their money, funds that invest in the US Treasury Inflation Protection Securities, or TIPS, have become a more popular choice or so I heard but this chart from Bloomberg doesn’t completely support that.

Funds that help investors with their fear of higher tax rates or a desire for safety show stronger inflows recently, but TIPS is in a solid position in gaining assets.

PIMCO offers three inflation-protected ETFs, the one covered here, the PIMCO 1-5 Year U.S. TIPS Index (NYSEARCA:STPZ), plus a total market version, the PIMCO Broad U.S. TIPS Index ETF (TIPZ), and one focused on the longer-dated segment, the PIMCO 15+ Year U.S. TIPS Index ETF (LTPZ). Until rates have peaked, I am more bullish on STPZ than the two others, both with exposure to TIPS maturing after five years. I did find one ETF that invests in short-term HY bonds that could be considered instead.

Index review

STPZ invests based on the ICE BofAML 1-5 Year US Inflation-Linked Treasury Index, which the provider describes as:

ICE BofA 1-5 Year US Inflation-Linked Treasury Index is a subset of ICE BofA US Inflation-Linked Treasury Index including all securities with a remaining term to final maturity less than 5 years.

Source: The ICE, GVQI

Three of the Index’s 18 bonds will need to be replaced before 2024. I suspect two already did as the Index seems to normally hold five in each maturity grouping. The full TIPS index, of which the above is a sub-index, provides more construction details:

The ICE BofA US Inflation-Linked Treasury Index (G0QI) tracks the performance of US dollar denominated inflation-linked sovereign debt publicly issued by the US government in its domestic market. Qualifying securities must have at least 18 months to maturity at point of issuance, at least one year remaining term to final maturity, interest and principal payments tied to inflation and a minimum amount outstanding of $1 billion. Strips are excluded from the Index; however, original issue zero coupon bonds are included in the Index and the amounts outstanding of qualifying coupon securities are not reduced by any portions that have been stripped. Securities issued or marketed primarily to retail investors do not qualify for inclusion in the index.

Source: The ICE

PIMCO 1-5 Year U.S. TIPS Index ETF review

Seeking Alpha describes this ETF as:

STPZ primarily invests in U.S. dollar denominated Treasury Inflation-Protected Securities with a maturity of at least 1 year and less than 5 years. It seeks to replicate the performance of The ICE BofAML 1-5 Year US Inflation-Linked Treasury Index, by using representative sampling methodology. PIMCO ETF Trust – PIMCO 1-5 Year U.S. TIPS Index. STPZ started in 2009.

Source: Seeking Alpha STPZ

STPZ has $1.4b in assets and provides investors will a 4.8% yield. PIMCO charges a reasonable 20bps in fees. The ETF holds 22 assets with a portfolio having a duration of 2.9 years; maturity of 3.0 years, and YTM of 3.2%

PIMCO lists three reason to consider their ETF:

• Seeks To Preserve Purchasing Power Against Inflation

  The fund seeks to help investors preserve purchasing power against inflation with low default risk by seeking real returns primarily from TIPS.

• Aims To Achieve Real Return, Capital Preservation And Low Volatility

  The fund aims to achieve the real return (above inflation), capital preservation, and low volatility level inherent in short maturity TIPS.

• Seeks Exposure To The Shorter Maturity Subset Of TIPS

  The fund seeks exposure to the shorter maturity subset of TIPS, which has historically had less interest rate risk, a higher correlation to inflation and lower volatility than a broad U.S. TIPS index.

Source: pimco STPZ

STPZ holdings review

This is a complete list of holdings as of today.

The Top 10 holdings equate to 81% of the portfolio value. Based on the Index rules, the 7/23 TIPS (#10) should need to be sold this month. I suspect it will be replaced by the US TSY N/B 0.5% 31/10/27, currently selling at $88, which is not currently held. STPZ does invest outside the Index as three bonds (5.5% of the assets) mature past the 5-year window it is based on. Adding the one I mentioned would become the 4th TIPS maturing after five years.

STPZ distributions review

While I own I-bonds, I have no TIPS ETFs so the fact STPZ missed some monthly payments was puzzling. The following two items explain why.

TIPS pay interest every six months based on a fixed rate determined at the bond’s auction. However, the interest payment amounts can vary since the rate is applied to the adjusted principal or value of the bond. If the principal amount is adjusted higher over time due to rising prices, the interest rate will be multiplied by the increased principal amount. As a result, investors receive higher interest or coupon payments as inflation rises. Conversely, investors will receive lower interest payments if deflation occurs.

Source: Investopedia TIPS

Interest payments from ETFs like STPZ is exempt for state and local taxes. Seeking Alpha gives STPZ its top grade for its dividend history: A+.

STPZ performance review

Between these sample ETFs, STPZ provided the smoothest ride and as the next chart shows, the best results so far in 2022 and over the past year.

Seeking Alpha also provides grades for five ETF factors and Quant scores.

Brief overview of PIMCO’s TIPZ & LTPZ ETFs

The Broad U.S. TIPS Index Exchange-Traded Fund (TIPZ) aims to achieve, before fees and expenses, the real return (above inflation) and the diversification benefits inherent in a broad U.S. TIPS index fund. Index used is the BofA Merrill Lynch US Inflation-Linked Treasury Index. TIPZ started in 2009.

Source: pimco.com TIPZ

TIPZ has $234m in assets and yields 5.6%. PIMCO also charges 20bps in fees. The ETF holds 42 assets with a portfolio having a duration of 7.6 years; maturity of 8.2 years, and YTM of 3.3%.

The 15+ Year U.S. TIPS Index Exchange-Traded Fund (LTPZ) aims to achieve the real return (above inflation), capital preservation, and greater exposure to changes in real interest rates inherent in long maturity TIPS. Index used is the BofA Merrill Lynch 15+ Year US Inflation-Linked Treasury Index. LTPZ started in 2009.

Source: pimco.com LTPZ

LTPZ has $467m in assets and yields 6.5%. PIMCO also charges 20bps in fees. The ETF holds 15 assets with a portfolio having a duration of 20.6 years; maturity of 22.5 years, and YTM of 3.5%.

Portfolio strategy

First I will compare how the PIMCO ETFs have done.

The shorter duration STPZ has the top CAGR for 3-yrs and shorter, and as expected, has the lowest yield. The next set of charts all come from the JPMorgan Comparison tool. I was able to include the full TIPS Index.

Data goes back to 2009, a period until recently when inflation was low and interest rates were level or falling. So while the two longer duration ETFs had better returns, in terms of risk/rewards, STPZ comes out on top. The drawdown data confirms STPZ was less volatile over this time period.

JPM stressed-test each ETF based on rising or falling rates. Since we are in the former now, I chose to present those results.

STPZ is the only one to show positive results during a period of rising interest rates. For both lowest risk and best results in a rate environment like now, STPZ is the superior TIPS ETF.

Now, I will compare STPZ against several other ETFs that invest in 1-5 years bonds other than TIPS. For this part, I will use the following ETFs:

• JPMorgan BetaBuilders 1-5 Year U.S. Aggregate Bond ETF (BBSA)
• Vanguard Short-Term Bond ETF (BSV)
• iShares Core Short-Term U.S. Bond ETF (ISTB)
• iShares Short-Term Corporate Bond ETF (IGSB)
• SPDR Bloomberg Barclays Short Term High Yield Bond ETF (SJNK)

The first comparison is the risk taken by each fund’s credit ratings allocations.

While IGSB has a large BBB allocation, only SJNK invests below that rating. BBSA and BSV are the closest to STPZ in owning AAA debt. The asset allocations differ and look like this.

Data shows little differences in effective duration or maturity allocations between the funds. STPZ performed better than this set of duration/maturity similar funds across all the time periods.

Only over the 3+ year period does another fund outperform STPZ, that being SJNK. The following risk data is only three years worth, reflecting the start of BBSA in 2019.

Here is how these funds did in prior times of rising interest rates. Again, STPZ handled them the best with one exception: SJNK was on top each time!

Final thought

After comparing STPZ against two longer-date TIPS ETFs and a set of non-TIPS funds that match it in terms of duration and maturity allocations, STPZ out does them all, except for SJNK. For investors willing to own non-investment-grade assets, that ETF is worth a look.