Vanguard Short-Term Inflation-Protected Securities ETF Opts For a Sound Approach

Vanguard Short-Term Inflation-Protected Securities ETF VTIP sensibly constructs its portfolio of short-term U.S. Treasury Inflation-Protected Securities and pairs that with a low fee.

The fund tracks the Bloomberg US Treasury Inflation-Protected Securities 0-5 Year Index, which includes TIPS with less than five years until maturity. The index weights qualifying bonds by their market value, which promotes low turnover and mitigates transaction costs. This is a sound approach because the TIPS market is liquid and does a good job of pricing these bonds.

TIPS offer a direct hedge against inflation because their principal is linked to the Consumer Price Index, which tracks the prices paid by on goods U.S. consumers. The value of the TIPS’ principal is adjusted higher when the CPI rises, resulting in increased coupon payments. TIPS funds would likely outperform a Treasury fund with similar maturities when inflation exceeds expectations. When inflation is lower than expected, a Treasury fund would likely outperform TIPS because the market’s expectation for inflation would already be baked into its price.

Credit risk is nearly nonexistent for TIPS because they are backed by the U.S. government. However, TIPS are exposed to interest-rate risk. Longer-term TIPS have higher exposure to interest-rate risk than shorter-term ones. This fund selects securities with less than five years to maturity, resulting in less exposure to interest-rate risk than its Morningstar Category peers that travel further along the curve. As of September 2023, its average effective duration was 2.47 years, 2.85 years lower than its average category peer.

Targeting short-term TIPS strengthens the fund’s sensitivity to inflation because short-term interest rates are more correlated with inflation than long-term rates and the inflation protection embedded in the fund’s performance isn’t overshadowed by interest-rate risk. This provides investors with better inflation protection and lowers the fund’s volatility.

TIPS are a narrow and homogenous sector of the bond market with limited potential for funds to differentiate their performance. Therefore, fees are a critical factor for investors to consider. The fund’s 0.04% expense ratio is among the lowest in the category, giving the fund a lower hurdle to keep pace with category peers.