Inflation Protected Treasury Securities (TIPS) – A Consideration When Everything Hurts
The markets are being hit with a combo of high inflation, rising rates, and an economy that is expected to slow further. Therefore, cash is losing value due to inflation, bonds are devaluing with rising rates, and the equity market is selling-off with lower earnings and higher discount rates.
Treasury Inflation Protected Securities (TIPS) are instruments issued by the Treasury designed to protect investors from inflation. To achieve this, the nominal value of the asset is adjusted with inflation – i.e., if inflation goes up, the value of the asset goes up proportionally – which subsequently leads to a higher coupon payment.
If your diversification strategy (e.g. holding a mix of stocks, bonds and cash) isn’t producing your desired results in the current market place, inflation protected securities may offer “protection.” TIPS may offer you an alternative protection that nominal fixed income or cash may not.
Keep It Simple with Treasury Inflation Protected Securities– TIP and STIP ETFs
Some exchange-traded funds (ETF) offer the ability to invest in treasury inflation-protected treasury paper. TIP’s and STIP’s are highly liquid, large-cap ETFs that invest in long-term (TIP) and short-term (STIP <5yr) government debt.
Due to its longer duration, TIP has greater exposure to real rates (the difference between expected inflation and the nominal rate of conventional treasury notes or bonds). Comparatively, the STIP will materially lower exposure to real rates due to its assets’ short duration. However, both ETFs offer the same protection to inflation – as inflation rises, the value of the underlying asset is adjusted to pass-through this increase to the value of the security and subsequently a higher coupon payment.
In 2022, TIP’s and STIP’s have lost 15.5% and 7.5% year-to-date, but recovered a portion of those losses through an increase in the current yield to 7.7% for TIP and 6.7% for STIP (dividends are paid monthly). This compares well with the 28.2% loss for the TLT (>20yr Treasury bond ETF) and 12.9% loss for the IEI (3yr to 7yr Treasury bond ETF).
What could go wrong with this type of strategy?
This strategy could be a short term safe harbor, though it is unlikely to be a long term performance driver. It is likely it would lag almost every alternative asset class if inflation is tamed, the Fed stops hiking, or the market loses the fear of a recession and equities rebound.
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