Fund expert offers tip on TIPs


"Like other US Treasuries, Treasury Inflation Protected Securities (TIPs) have virtually no credit risk," explains fund expert Mark Salzinger.

The editor of The No-Load Fund Investor adds, "Unlike other US Treasuries beyond short-term bills, however, TIPs also have no inflation risk." Here, he looks at an EYF based on TIPs.

"Twice a year, TIPs' principal valuis are adjusted upward by the amount of the increase in the Consumer Price Index Urban (CPI-U), thus protecting their holders against increases in inflation.

"The total return of the bond equals its yield plus the change in principal value based on inflation, changes in real interest rates (published interest rates minus inflation) and supply-demand in the market for TIPs.

"TIPs' yields are lower than those of regular Treasury sercurities of similar maturities. That's one of the disadvantages of TIPs.

"The other is that any increase in principal value due to the biannual inflation adjustment gets taxed every year as if it were received income.

"We favor TIPs when we believe that inflation over a period of five to ten years will be higher than the market expects. As of October 1, 20008, 10-year TIPs had a yield of 2.18% vs.3.66% for regular 10-year Treasuries.

"That means fixed-income investors expect the CPI-U to increase only by about 1.5% a year over the next 10 years. However, we believe that inflation is likely to be considerably higher than that over the period.

"While the credit crisis and the recent, substantial drops in most commodity prices will limit inflation over the short term, global growth in demand over the next decade is very likely to contribute to an increase in inflation in the US over the longer run.

"Also, TIPs provide extensive diversification benefits. According to the US Treasury, they have proviceed slightly negative correlation to the S&P 500 and to the US dollar (tending to inch up in price when the stock market or the dollar falls).

"And because of their inflation protection, they should have less volatility over the long run than regular Treasury securities of similar maturities.

"In our model retirement portfolio, we are establishing a new position in the iShares Lehman TIPs Bond (ASE: TIP) exchange-traded fund.

"The ETF can be bought just like a stock. Though there will be a commission, the miniscule expense ratio of this ETF (only 0.20%) quickly makes up for that, as most conventional TIOPs funds have much higher expense ratios.

"We also note that while the ETF replicates an index designed by Lehman Brothers, Barclays Global Investors acquired Lehman's indexing group in September and actually 'manages' the ETF."

Steven Halpern's TheStockAdvisors.com offers a daily look at the latest market commentary and favorite stock picks and investment ideas from the nation's leading financial newsletter advisors.

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Last updated: February 10, 2012: 03:30 AM

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