From TIPS to “phantom income” to varying distributions — Matt Tucker is here to explain what they are and how they are related.
I am going to delve a little deeper and explore an area of the market that can cause investor confusion — TIPS ETFs and distributions.
As their name implies Treasury Inflation Protected Securities (or TIPS) can help protect investors against inflation while also providing the potential for a secure income stream. The payments on TIPS are adjusted according to changes in the Non-Seasonally Adjusted US Urban Consumer Price Index, or CPI. That means the principal of TIPS increases with inflation and falls with deflation, as measured by the CPI.
TIPS are also valued by investors for their historically low correlation with other asset classes, which can make them a good addition to a diversified portfolio.
If you want exposure to TIPS you can buy them directly (the government sells them on TreasuryDirect.gov) or you can purchase TIPS ETFs Treasury Inflation Protected Securities (TIP) or Vanguard Short-Term Inflation-Protected Securities ETF (VTIP).
Market Realist – TIPS accrue a negative yield when the difference between the bond’s coupon rate and the current annual inflation rate is below zero. TIPS pay interest bi-annually at a fixed rate that’s applied to the adjusted principal. As a result, both the principal and interest payments raise inflation rates. In the case of deflationary pressure, the principal is adjusted downward and interest payments are also made on this depressed value. At maturity, the bond’s principal value is the value at the time it was issued.
TIPS have given a year-to-date return of 6.15%. The iBoxx 3-Year Target Duration TIPS Index Fund (TBTT) gave year-to-date returns of 1.24%. Meanwhile, the Vanguard Short-Term Inflation-Protected Securities Index Fund (VTIP) gave year-to-date returns of 1.32%.
On the other hand, short-duration straight Treasuries, as measured by the 1-3 Year Treasury Bond ETF (SHY), gave returns of a meager 0.28% this year. The iShares iBoxx $ High Yield Corporate Bond Fund (HYG) gave year-to-date returns of 3.93%, the iShares Core U.S. Aggregate Bond ETF (AGG) gave 3.76%, and the Vanguard Total Bond Market ETF (BND) gave 3.84%.
The iShares 7-10 Year Treasury Bond ETF (IEF) represents the longer end of the yield curve. It accrued year-to-date returns of 14.65%.
TIPS performance this year has been good. This is due to the rise in inflation we’ve seen over the past couple months.
Read on to the next part of this series to find out whether TIPS are the right choice for you.
© 2013 Market Realist, Inc.
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