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TIPS: Trend Change or Buying Opportunity?

May 09, 2013 | About:
Treasury inflation protected securities, or “TIPS,” have been a staple of many fixed-income portfolios as a means of protecting your purchasing power from the effects of rising consumer prices. Investopedia defines TIPS as: “A Treasury security that is indexed to inflation in order to protect investors from the negative effects of inflation. TIPS are considered an extremely low-risk investment since they are backed by the U.S. government and since their par value rises with inflation, as measured by the Consumer Price Index, while their interest rate remains fixed.”

The 800-pund gorilla in the world of inflation protected securities is the iShares TIPS Bond ETF (TIP) which boasts over $20 billion in total assets. You would think a bond fund of that size would be invested in hundreds of underlying securities, but a closer inspection reveals that there are only 36 treasury bonds in this ETF which makes it relatively non-diversified. This has to do with the low number of securities issued by the U.S. Treasury as compared to traditional treasury bonds. The weighted average maturity of the holdings is 9.07 years which means this fund is quite susceptible to price fluctuations based on changes in intermediate interest rates.

It is important to point out that TIP will not protect your portfolio from the effects of rising interest rates, rather the principal value of this ETF will respond favorably to rising core inflation. That is a distinction that I believe is misunderstood by many investors in these funds.

Looking at a chart of TIP below you can see that the fund has started to see signs of weakness and just crossed back below its 200-day moving average. It has had 8 straight down days over the last two weeks which may be a sign of a trend change in this sector of the bond market. However, when you look back over the last year it is important to point out that pullbacks like this were often very good entry points for a renewed surge in TIP.

10139881-13680337057046294-David-Fabian.

I am not ready to declare a red flag for TIP quite yet, but I would be concerned if the fund broke below $119.50 which is an area of support that held up earlier this year. Over the last several weeks we have seen a rise in the 10-Year Treasury Note Yield which has put downward pressure on intermediate term bonds. However, if we see a break down in the stock market, there will most likely be a flight to quality in treasuries that would benefit TIP.

Alternative Inflation Plays

There are several alternatives for inflation protected securities ETFs that you should also consider:

The first is to move to a shorter duration fund such as the PIMCO 1-5 Year U.S. TIPS ETF (STPZ) or the iShares 0-5 Year TIPS Bond ETF (STIP). Both of these ETFs have a similar makeup and because of their lower average duration, will have less sensitivity to interest rates. However, the payment of income from these funds can be erratic given the coupon schedule of the underlying holdings.

The second alternative is to consider going global with your strategy by investing in the PIMCO Global Advantage Inflation Linked Bond ETF (ILB). This is an actively managed bond fund that focuses on both emerging and developed countries. The U.S. only makes up 24% of the total holdings in ILB with Brazil and Mexico being the next top countries. ILB currently has 98 holdings and an average maturity of 9.78 years. On the chart below you can see how ILB has benefited from its international exposure over the last year as compared to TIP.

10139881-13680360383401346-David-Fabian.

The Final Word

If you are considering inflation-protected securities for your portfolio, I would recommend diligently researching the entire spectrum of ETFs available to determine the fund best suited to your needs. While TIP is presenting the best technical entry point at these levels, I would be hesitant to purchase it based on its U.S. focus and higher average duration. The other alternatives I mentioned might be a better fit based on their lower average maturity or global focus depending on the fund that you select.

About the author:

fabiancapital
David is currently the Chief Operations Officer and Managing Partner of Fabian Capital Management, a registered investment advisory firm. David has years of experience constructing actively managed growth and income portfolios using ETFs and mutual funds.

David’s responsibilities include: operations management, technology coordinator, chief compliance officer, investment research, client communication, marketing and portfolio management. In addition, David actively contributes to the Fabian Capital Management blog, podcasts, and special reports.

Visit fabiancapital's Website


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