Judging by their name alone, Treasury Inflation-Protected Securities would seem like a cure for one of today’s top investor concerns: inflation.
Unfortunately, that name doesn’t say everything you need to know.
A mutual fund or exchange-traded fund that invests in TIPS can help prevent rising prices from eroding the value of your investment portfolio. And inflation is a concern today: It’s running at an annual rate of 7 percent, a level not seen since 1982. That’s when “ET” landed in theaters and Michael Jackson’s “Thriller” hit the radio.
But TIPS funds and ETFs aren’t the best inflation fighters for all investors, and TIPS, a type of bond issued by the US Treasury, have complexities that belie their boiled-potato label.
People assume that “just because inflation goes up, you’ll do fine” with TIPS, said Lynn K. Opp, a financial adviser at Raymond James in Walnut Creek, California. But other factors, such as rising interest rates, can undermine TIPS yields. she said.
Also, TIPS are expensive compared to standard Treasuries because they pay less interest, Ms. Opp said. In the first week of January, a five-year TIPS yielded minus 1.7 percent, while a five-year Treasury yielded 1.4 percent. In effect, TIPS investors were paying the Treasury to hold their money.
Despite the negative returns, money has been rushing into TIPS funds and ETFs lately.
In 2020, about $22 billion of net new flows flowed into them, according to Morningstar. In the first 10 months of 2021 alone, those flows nearly tripled, to $61 billion.
The yield may have been the draw: The average TIPS fund tracked by Morningstar returned 5.5 percent in 2021, compared with a 1.5 percent loss for the Bloomberg Barclays Aggregate Bond Index, a highly competitive bond index. known.
To understand TIPS funds or ETFs, it helps to understand the underlying inflation-protected securities.
The US Treasury adjusts the principal of a TIPS twice a year based on the most recent reading of the consumer price index, a government measure of inflation. When the IPC goes up, the director goes up. And when the index falls, because prices are falling, it goes down.
“Interest payments can change,” said Gargi Chaudhuri, iShares chief investment strategist, Americas, for BlackRock, because those payments are based on principal that can change with inflation.
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The CPI has recently beaten expectations. But that situation has not always prevailed.
“If you look back a decade, inflation expectations were above where inflation rose year over year,” said Steve A. Rodosky, co-manager of PIMCO’s Real Return Fund. “So people would have been better off holding nominal Treasuries.” (“Nominal” is the professionals’ term for non-inflation-protected bonds.)
Perhaps the most confusing quality of TIPS is the nature of its inflation protection.
It might seem that a TIPS fund would work like hiking pants that zip into shorts: suitable for whatever (inflationary) conditions arise. But what sets TIPS apart is the protection they provide against unexpected inflation, said Roger Aliaga-Diaz, chief economist at Vanguard.
The market prices of all assets are adjusted, to a certain extent, to reflect anticipated inflation. The prices of standard bonds, for example, fall to compensate for the fact that inflation has taken away some of their original yields. TIPS prices also fall, although the crucial difference is that their inflation adjustments help offset that. (Bond prices and yields move in opposite directions.)
Whether you opt for a TIPS fund in your portfolio will likely depend on your age and expectations about inflation.
Retirees and people nearing retirement might choose one because its value should be less volatile than other assets that can help cushion inflation, such as stocks and commodities, Mr. Aliaga-Diaz said. Vanguard’s Target Retirement 2015 Fund, a so-called target date fund, allocates 16 percent of its asset value to TIPS.
Jennifer Ellison, a financial advisor in Redwood City, California, said her firm, Cerity Partners, currently recommends that clients keep 15 percent to 20 percent of the bond portion of their portfolios in TIPS funds. “But we’ve been as low as 10 percent at times,” she said.
A young person may not want any allocation to a TIPS fund, preferring stock funds as insurance against inflation.
“In the long run, there has been no better way to hedge against inflation than to have an allocation in stocks, because corporate earnings tend to grow faster than inflation, and stocks have appreciated faster than inflation. inflation”. said Ben Johnson, director of global ETF research at Morningstar.
Even for retirees, a less volatile type of stock fund, such as one that invests in dividend payers, might mitigate inflation better than a TIPS fund, Johnson said.
“Among our favorites is the Vanguard Dividend Appreciation ETF,” he said. “You own stocks that have increased their dividends for at least 10 consecutive years. That is a way to reduce risk a little bit while maintaining some exposure to equities.”
Another stock option is Fidelity’s Stocks for Inflation ETF, which holds shares of companies in industries that tend to outperform during times of inflation.
If you opt for a TIPS fund, choose one with low costs, Johnson said. Costs always matter in investing, but they’re especially important here because all of these funds generally do the same thing: they buy a single type of Treasury.
“In the TIPS market itself, it is extremely difficult to add value,” he said. Therefore, portfolio managers are often allowed to add a portion of other types of bonds, as well as derivative securities. “But you add risk by doing that.”
Among the cheapest TIPS offerings are the iShares 0-5 Year TIPS Bond ETF, the Vanguard Short-Term Inflation-Protected Securities ETF, and the Schwab US TIPS ETF. All three have expense ratios of 0.05 percent or less.
Inflation expectations present a more difficult puzzle for investors than your projected retirement date. In theory, if you think inflation will beat market expectations, a TIPS fund would be a good bet.
Investment professionals make this assessment by checking the break-even rate of inflation: the difference between the yields on TIPS and nominal Treasuries.
“It’s the rate of inflation you need to average out for TIPS to outperform nominal Treasuries over the period you’re investing,” said Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research. In the first week of January, that rate was about 3 percent for five-year Treasuries versus five-year TIPS.
People who think inflation will exceed that level for the next five years might want a TIPS fund. (You might also want to ask yourself why your intuition for inflation is better than the market’s.)
Another annoyance is how TIPS funds report their returns.
The US Securities and Exchange Commission requires a standard formula for calculating yields: the 30-day yield. That formula doesn’t work well for TIPS offerings because regular adjustments of principal to underlying securities can distort its result.
Some fund companies calculate the 30-day return, including principal adjustments; some don’t.
State Street Global Advisors, which sponsors the SPDR Portfolio TIPS ETF, is among those that don’t.
“From our point of view, it’s more conservative not to include the adjustment for inflation,” said Matthew Bartolini, SPDR Americas’ head of research for State Street. “Including it can lead to a misleading statistic: the fund’s bottom line performance is likely to be overstated.”
Perhaps the crucial fact to know about TIPS funds is the most basic: they are bond offerings, affected by the same macro factors that affect other bonds.
“If interest rates go up, the price will go down, regardless of what happens with inflation,” said Ms. Jones of the Schwab Center.
He also warned that “there is no guaranteed way to beat inflation.”
A TIPS fund could help. The same could happen with a suitable stock fund. “Having some allowance for things like real estate investment trusts and precious metals also makes sense, but that’s not necessarily going to beat inflation either,” he said.
Source: www.nytimes.com