We recently got on the phone with Chris Caltagirone, vice president and product manager at PIMCO, to discuss anything and everything related to TIPS, including their role in your portfolio and exchange traded funds (ETFs).
What are TIPS?
TIPS are Treasury Inflation-Protected Securities. TIPS are similar to regular Treasury bonds in that they have the same credit risk – effectively none – and they’re issued by the government. But the difference is how they pay the coupon. “If you buy $100 at inception and the rate of inflation is currently 2% for 10 years (the date of maturity), the principal will grow 2% each year,” Caltagirone says.
When were they created?
They were created in the United States in 1997. It was something the Treasury had thought about doing for awhile, Caltagirone says. We’re far from the first country to offer them – the United Kingdom has had them since the 1980s. But the U.S. market for TIPS is now the largest in the world.
Why were they created?
The main reason TIPS were created was to give the public a debt instrument that is directly linked to the rate of inflation. “No other investment where it moves up and down with whatever inflation is measured at,” Caltagirone says.
The Treasury issued them for two reasons:
- There was demand for them
- They’re incentive for the Treasury to keep inflation in check. If inflation runs rampant, the Treasury knows it will have to pay more and more to TIPS holders. “It forces them to take inflation seriously,” says Caltagirone. “They’re a check and balance for the Federal Reserve and the Treasury.”
What’s the TIPS market right now?
It’s around $550 billion. Total U.S. debt is around $12 trillion, making TIPS about 5% of the total U.S. debt. The market for TIPS has grown, Caltagirone notes, and it could grow even more.
TIPS, being relatively new instruments, have not yet been tested in a period of stagflation. Will they hold up if this happens?
In theory, Caltagirone says, TIPS would hold up in a period of stagflation – that is, high inflation, low growth. “In the late ’70s, anything over five years of maturity suffered and the yields went up sharply. Inflation is the #1 enemy of regular bond that don’t have inflation protection.”