Advantages to TIPS in the Current Market

IndexUniverse has an article up about TIPS and the corresponding ETFs that capture the space. The article questioned the utility of TIPS relative to other segments of the bond market and also questioned how CPI is calculated. The calculation of CPI does have real problems and I wouldn't suggest going real heavy in any segment of the bond market ,but the article overlooked (or at least I did not see this) an important piece of information about TIP's payout.

The article correctly notes that the 30 day SEC yield is 1.36%, but there is more to the story.

The table is from ETFconnect. The monthly payout has gone up considerably in the last months. The reason for this is that the fund pays out, as part of the fund's dividend, what would be the par value adjustment for the individual issues. I verified this on the phone with them a couple of weeks ago for a TSCM article.

The average monthly payout over the last three months has been $0.8288. TIP closed yesterday at $105.82 giving the fund a 7.8% yield. Pretty good, eh?

Well, it is pretty good, but thinking 7.8% is exactly the wrong way to look at this. The dividend is never the same two months in a row. It has gone up lately because CPI, flawed and understated though it may be, has been going up.

The yield on just about every bond ETF I have ever looked at is a moving target but I think, I say I think, it can remain on the high side for a while as CPI seems destined to stay elevated for a while. The fund is $7 off of its high and seems like it has correlated fairly closely to iShares Lehman 7-10Yr Treasury Bond Fund (IEF) for most of the last couple of years.

This is not a suggestion that anyone buy TIP, which I own for clients, but to realize that although the fund is not perfect it does have quite a bit of utility. If you are going to use ETFs I think it is important to realize that there are drawbacks with all of these funds, hopefully you weigh both the positives and the negatives before diving in.

Comments

[DaveyH:]

TIPS have one characteristic that makes them more valuable than conventional bonds (or bond funds) of similar quality, yield and duration. That is as an insurance policy against inflation. Some part of the cost of TIPS must be ascribed to a premium for that insurance. The value of such a premium is of course debatable.

2008 Aug 15 01:38 PM

[notsosmart:]

until the gov. gives true cpi(never happen) forget tips.the inflation rate of the 5 basic daily needs is app.15-16%.dont believe anybody about anything. think for yourself. all have an agenda.mostly-their hand in your pocket.

2008 Aug 16 11:44 AM

[searcher:]

Thanks Roger. I read the piece you reference, as well. Not to be too testy but it does get tiresome to have the well known shortcomings of the CPI 'revealed' as if it were determinative in any discussion about inflation hedges. Any metric by definition will be either incomplete or so comprehensive as to become a diffuse generalization. An investor might take note of the faults and make the appropriate adjustments according to their lights and still seek the advantage of the correlation to the degree it has utility.

2008 Aug 16 12:39 PM

[Roger Nusbaum:]

searcher, i think i am agreeing with you. i am saying you know it's flawed, i know its flawed, here are some positives despite the flaws, weigh the two sides and decide for yourself.

2008 Aug 16 04:23 PM