Perspectives on how Treasury Inflation Protected Securities (TIPS) can offer some protection against longer-term inflation and provide some diversification in any fixed income portfolio.
-Brian Weinstein, managing director, head of inflation-linked strategies & senior portfolio manager, BlackRock
-Martin Hegarty, co-head of BlackRock’s global inflation-linked portfolios, Blackrock
April 30, 2012
While the current rate of core inflation is muted, the Federal
Reserve’s incredibly accommodative monetary policy means
that higher rates of inflation may be on the horizon, and
investors should be prepared. With the potential impact
inflation can have on a portfolio, investors of all types are
asking: So what do I do with my money? To provide some
answers, we spoke with BlackRock’s senior inflation-linked
fixed income experts. In this interview, they offer perspectives
on how Treasury Inflation Protected Securities (TIPS) can
offer some protection against longer-term inflation and
provide some diversification in any fixed income portfolio:
With interest rates sitting at historically low levels,
investors need to consider how well they are being
compensated for future inflation.
We believe that TIPS serve a significant and important
role in any investor’s fixed income portfolio by providing
insurance against future inflationary pressures without
taking on more credit risk.
Managing inflation risks is particularly important for
investors moving into retirement, since they likely hold
a significant allocation of lower-yielding, high-quality
fixed income assets.
What are TIPS and how do they work?
Treasury Inflation Protected Securities (TIPS) are Treasury bonds
that carry inflation protection. Like nominal Treasuries (those
that are not adjusted for inflation), TIPS are issued by the US
government with a stated real interest rate, and the government
pays interest every six months based on this rate. Unlike nominal
Treasuries, however, the principal amount of TIPS is linked to
the Consumer Price Index (CPI), which is a measure of a fixed
basket of goods and services purchased by the average consumer.
This basket includes, among other things, essentials such as
food, energy, apparel, as well as medical and education costs.
When inflation, as measured by the CPI, rises, the principal
of TIPS will increase (as will the amount of the semi-annual
interest payment), making these bonds an effective hedge
against rising inflation for fixed income investors.
Why should an investor consider TIPS now?
While we would argue that it makes sense to hold TIPS in any
environment, we believe that it is even more important now
given the historically low level of nominal yields. Furthermore,
large government budget deficits, the Federal Reserve’s zero
interest rate policy and expanded balance sheet increase the
risks of future inflation. Fixed income investors should view
an allocation to TIPS as an insurance policy against potentially
higher rates of inflation in the future. Over time, inflation has been
volatile, and since the inflation lows in 2009 the recent trend has
been up. A skilled investment manager can take
advantage of tactical investing opportunities through differences
in the relative value of individual TIPS securities and TIPS versus
nominal Treasury securities based upon their view of future
inflation rates. TIPS also can provide some diversification to a
portfolio, as the price movements are determined by changes in
real rates which are not perfectly correlated to changes in nominal
rates. Investors should note that diversification does not ensure
profits or protect against losses.