Why TIPS ETFs Have Negative Yields

February 2nd at 12:24pm by John Spence

Treasury Inflation-Protected Securities and exchange traded funds that invest in them continue to see solid demand despite the fact the bonds are paying negative yields.

“A $15 billion auction of Treasury Inflation-Protected Securities this month drew the strongest demand since March even though yields on the notes average less than zero percent for the first time,” Investment News reports.

There are several ETFs tracking TIPS, but iShares Barclays TIPS Bond Fund (NYSEArca: TIP) is by far the largest with over $23 billion in assets. Other funds in the category include PIMCO 1-5 Year TIPS (NYSEArca: STPZ), SPDR Barclays Capital TIPS (NYSEArca: IPE) and Schwab U.S. TIPS (NYSEArca: SCHP).

The iShares TIPS ETF has a negative 30-Day SEC yield.

“Even with real rates being negative, investors view TIPS as the optimal place to put your money if you do have to buy U.S. bonds because it is still government paper while also protecting you from long-term inflation,” George Goncalves, head of interest-rate strategy at Nomura Holdings, told Investment News.

TIPS have outgained comparable Treasury bonds over the past decade, according to the article. The iShares Barclays TIPS Bond Fund was a solid performer in 2011, rising 16% over the past year.

When individuals invest in TIPS, the bonds’ principal is hitched to changes in the Consumer Price Index.

“There’s nothing that sounds more ludicrous than accepting a negative interest rate on your money. At least in the case of a certain type of Treasury bonds, though, negative rates suggest that investors are willing to pay up for protection against a potentially huge threat looming on the horizon: inflation,” the Motely Fool reports.

“But what’s particularly frustrating for income-seeking investors is that despite TIPS … seeming to be poised for a big ramp-up in consumer prices, those price increases haven’t for the most part shown up yet. The net result may be that although long-term investors have seen some big gains from TIPS they bought years ago, current investors are likely dooming themselves to poor returns going forward,” it predicts, adding that stocks may be a better inflation hedge.

Conversely, Investopedia recommends that TIPS still have appeal for longer-oriented portfolios despite the negative yields, which it says is a little misleading.

“These bonds are designed to provide a fixed coupon plus a rate that is adjusted based on changes in the CPI. This prevents erosion of purchasing power. So as inflation increases, investors gain that, plus the bonds coupon rate. While as total return component TIPS, probably don’t make much sense, but as an inflation hedge they still remain top notch. Inflation isn’t a guarantee. However, the possibility is gaining momentum,” Investopedia points out.

It should be noted the government-reported CPI has faced criticism that it underestimates inflation.

The so-called inflation break-even rate is hovering around 2%. The rate is determined by comparing the 10-year Treasury bond yield with the 10-year TIPS yield.

“The difference is the rate at which inflation would have to be above over the next 10 years in order for an investor to be better off owning the TIPS than the Treasury bond. The inflation adjustment does swing both ways, though, so any decrease in the CPI will result in a decrease of TIPS principal,” says Morningstar analyst Timothy Strauts.

iShares Barclays TIPS Bond Fund


Full disclosure: Tom Lydon’s clients own TIP.

The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.