Real Return ETF Investing 101 (RRF, CPI, RLY)

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July 12, 2012 1:48pm NYSE:CPI NYSE:RLY

Eric Dutram: Although inflationary pressures remain at subdued levels, some investors are worried about the recent monetary and fiscal actions taken by governments that might raise inflation in the near future. In order to combat this, a look at real return ETFs

could be a good idea (Read: Can You Fight Inflation With This Real Return ETF?).

The real return ETFs provide investors with protection against inflation, acting as a hedge against price increases (Read: Is It Time To Buy The Hedged Currency ETFs?). This strategy not only combats monetary instability arising in a specific country, but also protects future income for the long term. Thanks to investors’ concerns, ETF targeting this space are gaining a rather large following over the past few years.

Real return ETFs have made protecting against inflation relatively simple by using a basket approach with low costs and lower levels of risk. Products in this segment also arguably provide attractive and safer returns in the crumbing market and inflationary periods because of their low or negative correlation with broad stock markets.

While TIPS ETFs as well as funds tracking precious metals are always decent options, they may not at times provide enough diversification in the shaky markets (Read: PIMCO Launches Global TIPS ETF). Investors fighting inflation could choose from the three real return ETFs, each of which we have highlighted below:

WisdomTree Global Real Return Fund (RRF)

Launched in July 2011, this is an actively managed fund designed to deliver total returns (capital appreciation plus income) that outpace the rate of inflation. The product puts about 72% assets in the inflation-linked bonds and the remainder goes towards commodities.

Unlike other funds in the space, RRF doesn’t limit its exposure to U.S. TIPS, but also embraces securities from developed and emerging markets as well. South Africa, Australia, United Kingdom, Chile, Mexico, Canada, Sweden, Turkey, France and Brazil are some of the countries included in the fund, suggesting a wide swath of nations are represented (Read: Top Two Emerging Market USD Bond ETFs Head-to-Head).

On the commodity side, the exposure is spread across various sectors with precious metals and grains in the top positions, while energy, industrial metals, livestock, broad softs, and natural gas fill up the remaining basket (Read: Top Commodity ETFs In This Uncertain Market).

The fund has total assets of $4.7 million under its management and is highly diversified in the fields of country, currency, sector and commodity. The ETF also benefits from the derivative instruments such as swaps, forward currency contracts and futures contracts. As a result, the fund is suitable for long-term holding and provides strong protection against inflation.

The fund charges 60 bps in fees per year from investors and trades in very small volumes of about 1,600 shares on average daily basis. The product pays out 3.11% to investors in 30-day SEC yield terms and 0.79% in distribution yield. These low rates along with the weak commodities have caused RRF to underperform the market as the fund has lost about 5% since inception (Read: Three Unlucky Equity ETFs).

Although the fund has failed to match the rate of inflation over the past several months, it could equal or even outperform if bonds disburse sufficient yields to offset any loss from capital appreciation.

IndexIQ Real Return ETF (CPI)

Investors seeking another inflation hedge can find this ETF as an interesting choice (Read: AlphaClone Launches Hedge Fund Tracking ETF). It is structured as a fund-of-funds and seeks to match the price and performance of the IQ Real Return Index, before fees and expenses.

The fund employs a passive approach and provides exposure to vast categories — domestic large and small cap equities, international equities (Europe, Australasia, & Far East), government bonds, real estate, commodities, foreign currencies and futures. The fund consists of:

  • Five equity ETFs — SPDR S&P 500 Fund (SPY), iShares S&P 500 Index Fund (IVV), iShares Russell 2000 Index Fund (IWM), Dow Jones U.S. Real Estate Index Fund (IYR) and Vanguard REIT Index ETF (VNQ)
  • Three bond funds — iShares Barclays Short Treasury Bond Fund (SHV),  iShares Barclays 20+ Year Treasury Bond Fund (TLT) and SPDR Barclays 1-3 Month T-Bill ETF (BIL)
  • One commodity fund — DB Gold Fund (DGL)
  • One currency fund — CurrencyShares Euro Currency Trust (FXE)

With AUM of $27.4 million, the product generally focuses more on short-term bonds allocating about 69% in two ETFs — SHV and BIL. Beyond these two funds, it allocates about 10% of assets in SPY and TLT each. Since its launch in October 2009, the fund has managed $27.4 million of assets and trades in good volumes of about 11,000 average daily shares (Read: Seven Biggest Bond ETFs By Assets Under Management).

The fund is inexpensive, charging only 48 bps per year in fees and gaining about 3% over the last year (as of March 2012). The product has done a good job of matching the rate of inflation. However, this return is not assured in the future, as CPI is more skewed towards the U.S. securities than its real return ETF counterparts. The product yields 0.02% dividend annually, which is considered low compared to others in the space (Read: 11 Great Dividend ETFs).

SPDR Multi-Asset Real Return ETF (RLY)

This fund is the new entrant in the space by State Street, the second largest ETF provider after BlackRock’s iShares (Read:State Street Debuts Two Bond ETFs). It was launched in April 2012 and currently manages assets worth $5.6 million. The product is an actively managed fund and seeks to provide capital appreciation while protecting investors from inflation with the current income.

The fund follows other real return ETFs with different asset classes such as inflation-protected securities (issued by the U.S. government, foreign governments, agencies or instrumentalities), domestic and international real estate securities, commodities and natural resources companies.

The fund holds 15 ETFs in the basket. SPDR S&P Global Natural Resources ETF (GNR) takes the top spot with nearly 24% share alone, while SPDR Barclays Capital TIPS ETF (IPE) and SPDR DJ Wilshire REIT ETF (RWR) comprise 17% and 15% share, respectively (See more ETFs in the Zacks ETF Center).

The product is the high cost choice in the real return ETF space, as it charges fees of 70 bps per year. Since it is a new fund and not popular yet, it trades in a minimal average daily volume of about 4,700 shares. The product has underperformed since inception, delivering negative returns of more than 7% and paying out 1.77% to investors in 30-day SEC yield terms.

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Written By Eric Dutram From Zacks Investment Research

In 1978, Len Zacks discovered the power of earnings estimates revisions to enable profitable investment decisions. Today, that discovery is still the heart of the Zacks Rank, a peerless stock rating system whose Strong Buy recommendation has an average return of 26% per year.

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