GLOBAL - State Street global Advisors (SSgA) says that although Treasury Inflation Protected Securities (TIPS) are perceived as boring "if something seems deadly uninteresting, you often want to buy it. If everyone is talking about a type of investment, steer clear."
Heydon Traub, SSgA managing director, global asset allocation, highlights the recent technology stock boom and bust in making his point: “You had to have been in a cave the last few years not to know that the bubble burst and investors lost their shirts on these stocks as a whole. And the best asset class in 2000? You guessed it. TIPS rose about 13%.”
The US government began to issue TIPS in 1996 as a way for investors to buy bonds without the usual risk of losing money when inflation increased more than expected. With TIPS, the bond’s principal value is increased each year by the amount of inflation.
Traub said the case for TIPS, currently, is that investors are betting that inflation stays very low: “Looking at the traditional 10-year government bond and the inflation-protected equivalent bond the yields are 5.3% and 3.4%, respectively. This implies that investors expect inflation to be around 1.9% over the next 10 years, in which case the return on the two bonds would be the same.
“However, it seems more realistic that the bonds with the inflation protection should provide a lower return over time since an owner of that bond faces no inflation risk while the owner of the ‘normal’ bond does face inflation risk. So some might argue this implies investors expect about a 10-year inflation rate of 1.5%. With the exception of the Depression in the 1930s, the only time inflation was this low since then came in the 10-year periods ending in the early 1960s.
“With the economy on the road to recovery, it seems unlikely inflation will come in below 2% over the next 10 years. If that turns out to be the case, investors would be better off owning TIPS as opposed to regular government bonds. In addition, the volatility should be less or equal over this time from TIPS.”
Traub adds: “One other favourable event coming up is the retirement of one of the issues that mature in July. As these bonds are paid off, managers of TIPS funds will have to reinvest the proceeds into the remaining TIPS bonds, pushing those prices higher.”
He concludes that no one will get rich investing in TIPS but for protection from inflation, especially as a complement to other bond investments, TIPS fill the bill.
“In addition, given the low risk nature of these bonds, they make a reasonable alternative to low-yielding money market funds for those willing to edge out just a bit on the risk spectrum.”
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