Nancy Davis sat down with HedgeEye’s Keith McCullough to discuss how her fund, The Quadratic Interest Rate Volatility and Inflation Hedge ETF (IVOL) is different than Treasury Inflation-Protected Securities (TIPS) alone because it looks beyond the Consumer Price Index (CPI) as a single reference point for inflation.  

Keith

Before I take other people's questions, can you explain the difference between The Quadratic Interest Rate Volatility and Inflation Hedge ETF (IVOL) and Treasury Inflation-Protected Securities (TIPS)

Nancy

Generally? Well, I think the big problem with TIPS, and I know you and I agree on this, is that they're bonds. So they're all long duration. Yeah, the problem with TIPS is, if you actually have inflation move higher, especially with the Federal Reserve (Fed) not doing Quantitative easing (QE), the rest of the world is basically going to be buying our debt. And so, as inflation moves higher, you would expect higher long-term yields because of more term premium IVOL actually has a way to benefit from that, versus most people, when they're worried about interest rates, they just own short duration bonds, but it's, it's like a fake name, right? It's not short anything, it's just really less long duration.

So it still is guaranteed to lose money. Whereas we have a way to profit from higher long-term yields are lower front-term yields. And then the other problem with TIPS by themselves, whether it's the Schwab US TIPS ETF (SCHP), or TIPS is its the only index, like think about it’s the CPI, which came out this morning, right Consumer Price Index, and a third of it is rent. So it's just not the only way to measure something as big as inflation like nobody would ever buy, I don't know, the NASDAQ or the Dow Jones and say, ta-dah, I have the US equity market. Why would you ever do that with something as big and as hard to measure as inflation? And that's why I think using rate differentials, like where lenders lend money is a very simple way to say this is inflation expectations outside of CPI.

Keith

It's simple, but it's sophisticated relative to the norm.