Stimulus fears boost demand for havens from inflation

Exchange traded funds updates

Growing anxiety about the possibility of a sharp pick-up in inflation globally is driving some investors to switch into bond-based exchange traded funds designed to offer protection against monetary debasement.

For several years, investors have been largely able to ignore inflation as a risk. But, recently, market participants have become fearful that huge levels of central bank and government fiscal stimulus — designed to support economic activity in major economies during the coronavirus pandemic — could finally reawaken sharp price rises. US consumer price inflation readings in April, May and June were higher than forecast, adding to the concerns in recent months.

Such worries have pushed a growing number of investors to seek shelter this year in inflation-linked bond ETFs and other passive tracker products that either hedge against, or are less sensitive to, higher inflation.

From the start of the year until August 5, net inflows into inflation-protected bond ETFs totalled $27bn globally, according to data provider EPFR. That compares with $16.3bn for the whole of 2020.

“The focus on inflation over the past nine months is completely different to the past 10 years,” says Michael John Lytle, chief executive at Tabula Investment Management, a specialist in fixed-income ETFs.

A shopper wears a mask as she looks over meat products at a grocery store in Dallas © LM Otero/AP
A man wearing mask pumps gasoline at a Shell gas station
A man wearing mask pumps gasoline at a Shell gas station © Steven Senne/AP

A recent Tabula survey of 50 wealth managers and 50 institutional investors in Europe, managing €97bn in assets in total, found that 52 per cent of respondents were “very concerned” about inflation, with a further 38 per cent “quite concerned”. It also showed that 34 per cent expect flows into inflation-linked exchange-traded products to increase dramatically over the next year.

Lytle says Tabula’s TINF fund, which invests in Treasury inflation-protected securities (Tips) and other inflation hedges, had recently grown from very low levels of investment to around $100m in assets, with most inflows coming this year.

As well as inflation-linked bond ETFs, investors have also turned to other types of tracker fund to protect themselves against rising prices.

Products with floating rate note exposure have grown in popularity. For example, the SPDR Blackstone Senior Loan ETF has swelled from $2.2bn in assets at the end of last year to around $6.5bn.

Portrait of Brent Olson
Brent Olson, head of fixed income iShares in EMEA for BlackRock

Investors have looked to investment-grade floating rate funds, as well, or they have moved into shorter-maturity products, which are less sensitive to inflation. “The theme has been to move [maturities] a bit shorter,” says Bill Ahmuty, head of the SPDR fixed income group at State Street Global Advisors.

Brett Olson, head of fixed income iShares in Emea for BlackRock, says he can see inflows into these inflation shelters being sustained. “We expect inflation to build steadily over the medium term as easy monetary policy allows the US economy to run hot,” he explains.

“In that scenario, the recent allocations to inflation-linked bond ETFs are likely to continue, as well as allocations to short-duration corporate and government bonds to minimise rate volatility.”

But while flows into inflation hedges have picked up this year, they are still small relative to flows into bond ETFs as a whole, which remain popular even though many do not provide protection against inflation.

Investors piled into bond ETFs last year as the spring’s Covid-induced equity market slump and economic damage from the pandemic left many looking for safe havens. According to data group ETFGI, total inflows, net of withdrawals, into fixed income ETFs as a whole even outpaced flows into equity ETFs in the first half of last year. For the whole of 2020, bond ETFs sucked in a net $230.5bn.

In the first half of this year, net inflows into bond ETFs ran slightly ahead of last year’s rate: at the midpoint of the year they were $111.7bn. Total assets in bond ETFs now stand at $1.53tn, according to ETFGI, making them the second-biggest category of ETF.

By contrast, despite this year’s inflows, inflation-linked bond ETFs still account for just $101.9bn in assets, less than 7 per cent of the total.

That has left some industry insiders questioning whether investors in these products could be in for a rude awakening if inflation does indeed move significantly higher. That would erode the value of fixed income securities whose coupons are not linked to consumer price rises. 

Michele Gesualdi, the founder of London-based Infinity Investment Partners, says some investors have moved into fixed-income ETFs that are not protected against inflation as a way of hedging against a further economic slowdown caused by coronavirus — a situation in which bonds would likely do well. “But, if you’re wrong you could lose a lot of money,” he says.

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