Since 1997, the U.S. Government has been issuing Treasury Inflation-Protected Bonds (“TIPs”) to investors and savers who are interested in protection against a persistently rising cost of living. Originally, there were short maturity (5-year), medium maturity (10-year) and longer maturity (20-year) TIP issues. In 2009, 20-year TIPs were replaced by 30-year maturity TIPs.
By 1997, many savers had become disenchanted with low-return U.S. Savings Bonds, and TIPs presented an extra “kicker.” Not only Inflation-Protected Treasury Bonds have a coupon yield, their principle values are also adjusted for reported inflation. The inflation adjustment is made by raising or lowering the principle value of the bond by the rate of inflation for the prior year (again, reported inflation, meaning the inflation rate which the government announces to the public via the Consumer Price Index, or “CPI”).
Investors with inflationary concerns have long held TIPs as a portion of their portfolio bond allocation. While savers can invest in individual TIPs at treasurydirect.gov, most investors prefer the flexibility of TIP mutual funds and ETFs. Van Wie Financial prefers to use ETFs for their flexibility and low operating costs.
Risk in investments involves variability of returns, and TIPs are no different. Both their underlying coupon interest rates and their inflation adjustment vary over time. Obviously, total investment returns from TIPs change with time and conditions, and some time periods are more profitable than others. Considering when to own, and when to sell, TIPs, is a decision based primarily on expectations regarding inflation and interest rates.
For years we have complained about inflation under-reporting by the government. That will likely never change, as the government has too much at stake. Cost-of-Living Adjustments (“COLAs”) are paid to employees, Social Security recipients, members of the military, etc., and are based on increases in CPI. Large inflationary increases mean increased government expenditures, requiring increased Federal deficits and National Debt.
The 52-week price range for the iShare TIP is between $107.37 and $123.16, and it closed Thursday at $121.85. With the current inflation report being negative and interest rates being close to zero, we cannot justify buying TIPs right now. According to a concept dubbed the “overnight test,” an advisor considers a simple test when determining when an asset should be bought or sold. The “overnight test” presumes that all portfolio assets were sold yesterday. In the morning, each asset is then subjected to the question, “Would you buy this today?” If the answer is yes, the asset is retained, but if the answer is no, it is a candidate to be sold.
TIP does not pass our “overnight test” right now. We would not be buyers in the current economy. For those holding TIPs in other mutual funds or ETFs, the logic is the same.
Long-term total returns on TIP (the iShare) have averaged 4% over the life of the ETF (2003 – present). Year-to-date, TIP has returned 4.41%, and this is only April. The TIP market price is up about 13% from its low of the past 52 weeks. It is not a stretch to think that realizing gains (by selling shares) would be a commonsense move, especially in tax-deferred Retirement Accounts. For taxable accounts, tax implications would enter into the equation. For our clients, we know their cost basis for those holdings, and can easily evaluate the impact of selling in terms of profit and loss.
In the near term, returns on TIPs are likely to be virtually nonexistent. The reason for this is the inflation adjustment, which can reduce the face value of the bonds. TIP (the iShare) pays a monthly dividend if and when the combination of underlying yield and the inflation adjustment are positive. However, if that total is negative due to inflation, no dividend is paid out until the value of the bond once again becomes positive with upward inflation.
Over the life of the ETF, TIP has occasionally paid a monthly dividend over $1.00/share. There have also been extended periods of time when the monthly dividend has been zero. At least for now, it appears that we are in for a zero (or very low) monthly dividend.
For current clients with TIPs, please consider what we have presented and let us know if you have questions or instructions as to how to handle your transactions. For people who are interested, we continue to meet with potential clients, although not yet face-to-face. Phone meetings can be scheduled on our website vanwiefinancial.com. Let’s stay safe out there, but let’s also keep communicating.