A Tip about TIPS

| About: iShares TIPS (TIP)

There was an article in Barron's this weekend, writes Roger Nusbaum, about an open end fund (symbol BBHIX) run by Brown Brothers Harriman that actively manages Treasury Inflation Protected Securities, also known as TIPS. According to the Barron's article (you'll need a subscription to see it) the fund's A shares carry a 3% load, has an expense ratio of 1.01% and a yield of 3.37 %.

Do you know what TIPS yield? A 4% headwind (load + expenses) the first year and 1% there after is a lot to overcome, too much in my opinion. This type of thing is one of the reasons why I so dislike open end funds, save for Pro Funds which I use occasionally for clients.

iShares has an ETF that owns TIPS (symbol TIP) that only has a 0.20% expense ratio, no load, and a yield of 3.20%. The iShares does have 17 basis points less yield but that is more than made up for in price appreciation. Over the last twelve months the TIP has outperformed BBHIX by roughly three percentage points, more than making up for the slightly lower yield. As a quick note, not too many people buy TIPS for the income but instead use them for protecting a bond portfolio against inflation.

So to sum up BBHIX is more expensive and it under performs. Why is this fund good for anybody? I really don't know.

There is one other feature that the TIP ETF offers investors; the ability to sell covered call options to enhance the yield. In looking at the options available you will not get very excited about the premium but remember that where TIPS are concerned we are trying to capture extra basis points. TIP is currently trading at $105 per share. The June calls with a strike of 108 can be sold for $0.30 and with a little patience perhaps $0.35. The trade I would consider would be to buy 500 shares of TIP and sell five of the June 108 calls (symbol TIPFD.O). The June 108's are 2.8% out of the money. It took 12 months for TIP to move 3% so while it is possible that TIP could move that much in only six months, resulting in having to sell shares at the 108 strike price at or before expiration, it seems unlikely. Selling five calls for $0.30 twice a year after paying two $10 commissions nets $280 per year which works out to and extra 50 basis points of yield per year on the position. That is not insignificant when the yield of the fund is only 3.20%.

To be clear, I am not saying the trade is not right for everyone. If you think inflation is really going to take off, selling calls would not be smart, the trade would leave too much on the table. Also, this may not be a good trade for someone that has never sold a covered call before. This idea is just that, an idea. In a low rate environment it makes sense to explore ways to enhance yield. The more important point of this article is to be very wary of a bond fund that will take about a year to make up the sales load.