WIP: International Inflation Hedge ETF, Above-Average 6.9% Dividend Yield (NYSEARCA:WIP)

I last covered the SPDR FTSE International Government Inflation-Protected Bond ETF (NYSEARCA:WIP) in early 2022. In that article, I argued that WIP made little sense as an investment, and seemed plainly inferior to funds focusing on U.S. treasury inflation-protected securities, or TIPs. WIP has underperformed relative to these securities and broader bond indexes, broadly in line with my expectations.

Right now, the fund yields 6.9%. Said yield is quite a bit higher than that of treasuries and investment-grade bonds, as inflation remains elevated abroad. Credit quality is high too, as the fund focuses on developed markets with investment-grade offerings. WIP’s high-quality holdings and above-average yield make the fund a buy, although the dividends are much riskier and more volatile than average.

WIP Basics

• Sponsor: State Street.
• Underlying Index: FTSE International Inflation-Linked Securities Select Index.
• Dividend Yield: 6.9%.
• Expense Ratio: 0.5%.
• Total Returns 10Y: 0.2%.

WIP – Overview and Analysis

International Inflation-Linked Bonds

WIP is an international inflation-linked bond index ETF. The fund focuses on developed markets. Country weights are as follows:

Specifics vary, but the fund’s underlying holdings are invariably linked to the inflation rate in their issuing country, and see higher dividends, capital gains, and/or total returns when inflation is high. As the fund’s portfolio includes a diversified set of developed market country bonds, it might make sense to think of the fund as a whole as being linked to inflation rates in developed countries, excluding the US.

Right now, average returns should roughly equal 1.9% plus inflation. Implied inflation for the fund’s holdings stands at 4.1%, for 6.0% in total returns. These are very rough figures.

WIP’s bonds being linked to inflation are their most important characteristic and their key differentiator. Although I don’t think there is anything inherently wrong with this, for U.S. investors securities linked to U.S. inflation rates seem broadly superior, and more aligned with (presumptive) investor goals.

U.S. investors might wish to hedge their portfolios against local inflation rates, as these directly impact their cost of living. This is not the case for foreign inflation rates: U.S. investors, by and large, are not affected by the cost of living in the U.K., Germany, or Brazil. For U.S. investors, hedging against foreign inflation seems somewhere between unnecessary and unwise, in my opinion at least.

In my opinion, all else equal, investors should prefer U.S. inflation-protected securities, or TIPs, over international inflation-protected securities. All else is not equal, however, with WIP offering investors one key benefit over their local counterparties. Let’s have a look.

Dividend Analysis

WIP currently yields 6.9%. It is a reasonably good yield on an absolute basis, and higher than that of most bonds and bond sub-asset classes. Most importantly, it is much higher than that of TIPs, their closest U.S. counterparty.

WIP also has a higher yield to maturity than TIPs too, although spreads are a bit tighter at 2.0%.

WIP yields more than TIPs for two reasons.

First, the fixed rate component of WIP’s underlying holdings is a bit higher. Compare WIP:

with TIPs:

The second reason is the fact that inflation in most developed countries is higher than in the U.S. As per the IMF, global inflation is 3.0% higher than in the U.S., and developed market inflation is 0.2% higher. Do bear in mind, that developed market inflation includes U.S. inflation, dragging the average lower. Sans the U.S., spreads would probably be in the 0.3-0.6% range.

On a more negative note, WIP’s dividends are incredibly volatile, as inflation itself is quite volatile, and these securities sometimes behave in odd ways. As an example, sometimes these securities exhibit capital gains (higher prices) which get classified and distributed as dividends. These oddities feed into dividend volatility. Compare dividend growth for the past one year versus three years:

Or look at the fund’s monthly dividends. It is quite common for dividends to double in a month, and to then get cut in half the next.

WIP’s dividend volatility is negative, and it also makes the fund somewhat difficult to analyze. There are large discrepancies between standard dividend yields and yields to maturity, for instance. I only feel comfortable stating that the fund’s dividends are higher than average because they are consistently so, across different metrics, and because spreads are reasonably wide.

In any case, WIP’s above-average 6.9% dividend yield is a significant benefit for the fund and its shareholders, especially considering the fund’s strong credit quality. Which brings me to my next point.

Credit Quality

WIP focuses on developed markets, with a couple of exceptions:

Credit quality is generally high, with the fund focusing on government bonds, with over 80% of the fund’s portfolio comprised of investment-grade bonds, with an average credit rating right in the middle of A – AA.

Overall, default rates for the fund’s portfolio are extremely low, and will very likely remain so for the foreseeable future. Developed countries like the UK, France, and Japan have not gone bankrupt in modern times, and I don’t expect them to default in the coming years either.

WIP’s strong credit quality reduces portfolio risk, volatility, and losses during downturns, all straightforward benefits for the fund and its investors. Said benefit is of particular importance considering the fund’s 6.9% yield: few investment-grade funds offer comparable yields.

WIP – Risks and Downsides

Foreign Currency Risk

WIP is an international bond ETF, whose underlying holdings are issued in foreign currency including pounds, euros, and yens. The prices of these securities change with foreign currency prices, exposing investors to foreign currency risk. Said risk manifests itself in two ways.

First, it directly increases dividend and share price volatility. WIP itself is almost twice as volatile as TIPs, for instance.

The second issue with foreign currency risk is that the U.S. dollar is a safe haven currency, and tends to rise in price during downturns and recessions. Due to this, WIP should underperform other investment-grade bond ETFs during downturns, as was the case in 1H2020. Bear in mind that underperformance during downturns is not a certainty, as the fund could outperform during a recession centered on the U.S., or one in which U.S. sentiment was particularly bearish.

Inflation-Linked Bonds

WIP’s bonds are linked to developed market inflation, and so see lower dividends and returns when inflation decreases. Inflation has trended down for months and seems likely to decline moving forward. I expect sizable dividend cuts, which is a straightforward negative.

A particularly severe issue with the above is the uncertainty of it all. I considered looking at forecasts for inflation to try to have an idea of how WIP’s dividends might change in the coming months, but the issues here just seem intractable.

It is basically impossible to forecast inflation with any sort of precision. Even if you could, WIP invests in dozens of countries, and the specifics of these securities do vary by country. Even if you do manage to build a reasonable forecast, the dividends on these funds are incredibly volatile and said volatility can easily cancel out any other effect, at least in the short term. The accounting of these securities is complicated, which makes interpreting some metrics difficult.

Notwithstanding the above, most of the forecasts I’ve seen do indicate that global and developed market inflation will remain somewhat elevated this year. The U.S. has been a bit of an outlier in this area, although not the only one. Under these conditions, I do believe that WIP’s dividends will remain competitive moving forward, but uncertainty and risk are high. Do remember that dividends are high right now, which counts for something.

Conclusion

WIP’s high-quality holdings and above-average 6.9% yield makes the fund a buy, although the dividends are much riskier and volatile than average.