{"id":90562,"date":"2024-04-15T23:41:40","date_gmt":"2024-04-16T03:41:40","guid":{"rendered":"https:\/\/ifintechworld.com\/?p=90562"},"modified":"2024-04-15T23:41:44","modified_gmt":"2024-04-16T03:41:44","slug":"with-breakevens-at-2-4-tip-looks-better-than-treasuries","status":"publish","type":"post","link":"https:\/\/ifintechworld.com\/?p=90562","title":{"rendered":"With Breakevens At 2.4%, TIP Looks Better Than Treasuries"},"content":{"rendered":"
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In keeping with my continued coverage on bonds and bond funds, thought to have a quick look at treasury-inflation protected securities, or TIPs. These securities have broadly similar characteristics to normal treasuries, with effectively zero credit risk, moderate rate risk, and reasonably good yields, albeit below-average. Unlike normal treasuries, TIPs are somewhat protected against inflation, seeing higher coupons when inflation increase, and vice versa.<\/span><\/p>\n

Right now, TIPs yield around 2.5% plus inflation, and should outperform normal treasuries with inflation rates higher than 2.4%. With inflation running higher than 3.0%, and with no short-term catalysts for a significant drop in inflation, TIPs look marginally stronger than normal treasuries. I continue to prefer high-quality CLO debt tranches, though, as these have higher yields and broadly lower volatility.<\/p>\n

I’ll be focusing on the iShares TIPS Bond ETF (NYSEARCA:TIP<\/span>) for the remainder of this article, but everything here should apply to other TIP funds in roughly equal measure.<\/span><\/p>\n

TIPs – Overview and Explanation<\/h2>\n

TIP is an index ETF investing in TIPs. As these are somewhat niche, uncommon securities, thought to start the article with a quick overview of these. Feel free to skip this section if you already know all about TIPs, or if you’ve read my previous articles on the subject.<\/p>\n

TIPs are treasuries<\/em>, issued by the U.S. treasury and backed by the full faith and credit of the U.S. federal government. Treasuries offer investors ultra-safe, albeit low, dividends, with effectively zero credit risk.<\/p>\n

TIPs have the added benefit that their dividends, capital, and returns, are somewhat protected against inflation.<\/p>\n

Specifically, their face value and coupon rate payments are indexed to the Consumer Price Index, or CPI, an inflation index, for positive values of said index. So, higher inflation means higher bond values and coupon payments. The opposite is technically true as well, although deflation can never reduce face values below their initial level, just erode prior increases.<\/p>\n

Let’s explain the above with a quick example.<\/p>\n

Say you invest $1,000 in TIPS at a 2% yield, equivalent to an interest payment of $20 per year.<\/p>\n

If inflation increases to 10%, so would the value of your investment and interest. Your investment would increase in value from $1,000 to $1,100, while your interest payment would increase from $20 to $22.<\/p>\n

Total returns would be equal to $100 plus $22, effectively equivalent to inflation plus interest rate (10% + 2%). Returns are generally distributed to investors in the form of dividends, with higher rates of inflation leading to greater gains and dividends.<\/p>\n

Deflation can impact the value of your investment and dividends, but can never cause these to decrease below their original level. In the example above, deflation of 10% could cause your investment to drop in value from $1,100 to $1000, but not<\/em> from $1000 to $900. In other words, deflation can reduce gains, but never lead to net losses.<\/p>\n

With the above in mind, let’s have a look at TIP itself.<\/p>\n

TIP – Basics<\/h2>\n