TIPS Aren’t Perfect

Treasury inflation protected securities or TIPs may not be as safe as investors think they are.

That’s according to the WSJ’s Tom Lauricella who writes that investing in TIPS through a fund can lead to losses because the share of the investment pool gets marked up or down in price on a daily basis.

TIPS offer coupon payments and yield to maturity that change along with the consumer price index so that investors get paid more a inflation rises.

TIPS are also protected in a deflation scenario.  If the CPI adjustment takes the principal at maturity below the bond’s face value, Treasury will still repay at par.

So, what could make the value decline?  The value of TIPS are also tied to interest rates.  Rising interest rates, which are bad for bond values, typically follow periods of higher inflation.  So even though coupon payments may be increasing, the underlying principal of the bonds are declining.

In the recent credit crisis, investors were unloading all asset classes while the economic slowdown kept a lid on inflation.  As a result, the iShares Barclays Capital TIPS Bond Fund (TIP) lost 3.8% between September and May.

For more on inflation protected ETFs, see the TIPS Fixed Income ETF Directory.

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