Investors Bail on TIPS Funds

Investors are exiting bond funds that promise to protect against inflation in droves. This phenomenon includes the category’s best-performing names, even though these TIPS funds (called as such because they invest in Treasury inflation-protected securities) have been putting up returns competitive with the rest of the government bond market this year.

Investors pulled $3 billion from inflation-protected bond funds in October, bringing the category’s year-to-date outflows to $22.3 billion. An 18-month streak has seen investors pull $50 billion from the group—an amount equal to 16% of its assets as of March 2022.

These outflows have caused assets in the category to fall to $214.8 billion as of the end of October. They previously reached a peak of $294 billion in December 2021.

Investors have often had poor timing when buying and selling TIPS funds, notes Jeff Ptak, chief ratings officer for Morningstar. In June, he wrote that while the average TIPS fund reported a gain of 1.8% over the past three years through April 2023, the average dollar invested in these funds lost 1.4%. “While TIPS funds can serve a useful purpose, the data we analyzed suggests that investors have struggled to use them successfully in practice,” he explained.

Additionally, when pulling money from TIPS funds, investors don’t appear to discriminate between top- and bottom-performing names, or whether they are actively managed or track indexes.

For example, the largest inflation-protected bond fund, the $51.7 billion Vanguard Short-Term Inflation-Protected Securities Index VTIP, outperformed 95% of TIPS funds in 2023 and over the last three years. Over the past 12 months, the fund gained 3.2% while the average inflation-protected bond fund was up only 0.6%. Still, investors yanked $4.1 billion from the fund over that timeframe.

Lord Abbett Inflation Focused LIFIX ranks in the top quartile for 2023 and in the 2nd percentile of all inflation-protected bond funds for the past three and five years, but it too has seen massive outflows—the largest in the category. The fund has nearly been cut in half over the past 12 months, from $2.2 billion in assets to $1.3 billion.

All this has happened even though these funds outperformed both Treasury and core bonds (albeit by a slim margin) in 2022. The Morningstar US TIPS Index is up 1.2% through Nov. 30, while the Morningstar US Core Bond Index is up 1.6% and the Morningstar US Treasury Bond Index is up only 0.7%.

“TIPS have not performed as well as people expected them to,” says Morningstar associate analyst Mo’ath Almahasneh.

TIPS Performance Dented by Rising Rates

TIPS gained in popularity in 2021, when investors poured more than $75 billion into the category. The Morningstar US TIPS Index gained 5.7%, while the US Treasury Bond Index lost 2.3% and the US Core Bond Index lost 1.6%.

The next year, TIPS struggled. In 2022, the US TIPS index lost 11.8% while the Treasury Bond Index lost 12.4% and the US Core Bond Index declined 13.0%. For some investors, these losses may have been unexpected. Inflation hit a 40-year high, but the investment they believed would protect them from rising prices was deep in negative territory.

Like any government bond, TIPS are sensitive to changes in interest rates. These funds tend to have long durations (a measure of interest rate sensitivity), and many suffered because of the Federal Reserve’s aggressive interest rate hikes. “The sharp rise in yields over the past two years meant TIPS prices declined, and so did their returns,” says Almahasneh. “Over short periods, price declines can offset the inflation protection benefits.”

In addition, TIPS are only meant to outperform relative to a Treasury bond of the same duration. Their performance is tied not to inflation on an absolute basis, but rather to the level of inflation relative to the market’s expectation.

Widespread Outflows from TIPS Funds

As performance turned negative, investors started to abandon TIPS funds in 2022, pulling $21.3 billion and causing the category to shrink by 7% on an organic basis. In 2023, investors have pulled more than $20 billion from the category. Given the lower starting point this year, the comparable level of outflows was even more severe on a percentage basis, with assets declining by 9%. Over the past 12 months, 70% of the 66 funds in the category have experienced outflows, and exactly half have seen organic outflows of 10% or more.

On an absolute basis, iShares TIPS Bond ETF TIP has experienced the largest outflow. The $19.7 billion fund has lost $4.7 billion over the past year, causing assets to organically fall by 18.7%.

TIPS funds with shorter durations have outperformed other strategies, as their portfolios are less affected by changes in interest rates. But investors have withdrawn from these funds as well. The $9.1 billion iShares 0-5 Year TIPS Bond ETF STIP ranks in the 12th percentile of returns for all inflation-protected bond funds over the past year, but investors have pulled $3 billion in that time, for an organic outflow rate of 25%.

Active funds have also seen large losses. The $28.5 billion Vanguard Inflation-Protected Securities VIPSX has seen outflows of $4.5 billion over the past year.

American Century Short Duration Inflation Protection Bond APOGX is another TIPS fund that shrunk dramatically despite doing well relative to its peers. Its 2.6% one-year return puts it in the 20th percentile of inflation-protected bond funds in 2023. Over the last 12 months, investors have pulled $833 million from the $1.8 billion fund, causing its assets to decline organically by one-third.

TIPS Funds With Largest Outflows