Ben Bernanke might not see inflation on the horizon, but after years of a high-liquidity diet from the Federal Reserve, historic deficit spending in Washington and little discernible economic growth to show for it, investors are rationally starting to wonder if inflation -- an undue and fraudulent expansion of prices -- could be forthcoming after a nearly 30-year hiatus.
In anticipation, many have been buying gold or commodities. Others are shorting bonds to bet on higher interest rates. Both moves, for various reasons, tend to correlate imperfectly with inflation itself.
Now a new pair of exchange-traded funds offer aim to provide a more precise solution by specifically following long-term inflation expectations, allowing everyday investors to bet on or against inflation just as big institutions have been for years.
ProShares 30 Year TIPS/TSY Spread (RINF) and ProShares Short 30 Year TIPS/TSY Spread (FINF) are benchmarked to the Dow Jones Credit Suisse 30-Year Inflation Breakeven Index, which tracks the market's expectation of inflation by measuring the difference in yields between TIPS, which are adjusted for inflation, and long-term treasury bonds, which are not. The spread between the two instruments, the yield of the Treasury less that of the TIPS, is known as the "breakeven rate" for inflation. This can be even more volatile than interest rates themselves -- it's dropped nearly 12%, and at one point nearly 19%, since last summer.
The funds' approach essentially nets out interest rate risk, leaving investors with a manner by which to wage or on the market's pure forecast for future inflation.
When TIPS outperform Treasurys of comparable duration, the market is signaling it expects inflation will increase, benefiting the ProShares 30 Year TIPS/TSY Spread fund. If inflation is expected to decline, ProShares Short 30 Year TIPS/TSY Spread (FINF), which shortsthe spread, should rise instead, although the spread is volatile and investors can easily lose money if their predictions don't pan out. Both funds charge an annual expense ratio of 0.75%.
After being introduced in 1993, the country's first ETF, the S&P 500 SPDR (SPY), initially languished as investors slowly learned how it could be integrated it into their strategies. While new products like RINF are still thinly traded and not widely understood, even a small resurgence in inflation could reinforce their utility. With all deference to Chairman Bernanke, history suggests inflation isn't dead, rather only lurking in the shadows before making a decisive and destructive return.
—Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC
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