Protecting against inflation is a popular investment strategy for many investors. And in their pursuit of inflation-hedging investments, Treasury Inflation-Protected Securities, or TIPS, often are investors’ top choices.
However, investors using TIPS must consider these securities’ duration1—a key measurement of sensitivity to interest rate movements. We believe that targeting a specific duration based on a portfolio’s interest rate exposure is key to successfully protecting against the threat of inflation. That being said, TIPS present more challenges to managing duration than most other fixed-income investments.
In this paper, we offer a closer look at some of those challenges. We then explain the methodology that the FlexShares iBoxx 3-Year Target Duration TIPS Index Fund and the FlexShares iBoxx 5-Year Target Duration TIPS Index Fund (TDTF) use to manage duration and interest rate risk in a portfolio that holds TIPS to hedge against the threat of inflation.
WHY TIPS REQUIRE A SPECIAL APPROACH TO DURATION MANAGEMENT
Although most investors believe that inflation isn’t likely to reach the same high levels as was seen in the 1970s, many investors still seek protection from its corrosive effects. One popular inflation-hedging investment vehicle is Treasury Inflation-Protected Securities, or TIPS. The value of these bonds is that their principal grows at the same rate that prices—as measured by Consumer Price Index—rise.
But while TIPS offer a relatively simple way to potentially hedge against rising inflation, investing in these bonds can prove to be more