San Francisco/New York - December 9, 2003. The iShares Lehman TIPS Bond Fund (ticker: TIP) began trading on the New York Stock Exchange last Friday. The fund is the only exchange-traded fund (ETF) available that tracks inflation-protected public obligations of the U.S. Treasury, commonly known as 'TIPS,' which are designed to provide inflation protection to investors. The new fund has an expense ratio of 0.20%.
“Because of low correlation to other asset classes, the iShares Lehman TIPS Bond Fund can help provide a high level of diversification in portfolios,' said Lee Kranefuss, CEO of BGI's Intermediary Business.
TIPS are income-generating instruments whose interest and principal payments are adjusted for inflation. The inflation adjustment, which is typically applied monthly to the principal of the bond, follows a designated inflation index, the consumer price index (CPI). A fixed coupon rate is applied to the inflation-adjusted principal so that as inflation rises, both the principal value and the interest payments increase.
The Lehman Brothers U.S. Treasury Inflation Notes Index measures the performance of the inflation-protected public obligations of the U.S. Treasury. As of September 1, 2003, there were 11 issues included in the Index. To be included in the index the bonds must be U.S. Treasury Inflation Protected securities, have at least one year to final maturity, and have at least $200 million par outstanding.
The U.S. Treasury first offered TIPS in 1997, and many investors use them to hedge against inflation, since the value of TIPS change in line with the Consumer Price Index (CPI). If the CPI goes up, then the value of TIPS (as well as the interest payments) also rise. However, investors receive some degree of protection against deflation because the final payment to cannot be less than the TIPS original par value. TIPS prices will go down when the CPI falls, but they can never go below the original par value.
“In any environment there are several components to your total bond return,” said J. Parsons, managing director of Barclays' intermediary business. “One factor is the general level interest rate movement, another is the shape of the yield curve, another is the spread that instruments trade over a standard Treasury, and the last is inflation. With TIPs, you’re protected against inflation – but you’re still exposed to the other risks.”
TIPS have become an increasingly popular asset class – Vanguard introduced a TIPS fund in 2000 that has nearly $4 billion in assets, according to the Vanguard website. The Vanguard fund has an expense ratio of 0.22% compared to 0.20% for the TIPS iShares – although investors must consider the brokerage commissions charged by all ETFs when calculating total costs.
“TIPS are an attractive investment,” said Morningstar analyst Christopher Traulsen. “One of the knocks against bonds is that they generally don’t offer enough return to keep place with inflation long-term – which is why people have stocks in their portfolios. With TIPS, their principal is indexed to the CPI. Since the coupon pays a percentage of principal, it also goes up with CPI. At maturity, you get the greater of the inflation-indexed principal or the original principal. So in the event of deflation, you won’t get less money back than you would have otherwise. The trade-off is that the yield is going to somewhat smaller than it would be for a Treasury with an equivalent maturity.”
Although TIPS have performed well lately, BGI’s Parsons cautioned that investors must be careful, as always, not to chase the hot asset class.
“TIPs are not a panacea – they’re just an effective tool that can fit into your portfolio, especially if you’re concerned about inflation,” said Parsons.