Amid rising interest rates, particularly with President Trump occupying the Oval Office, Ross Gerber embraces the idea of investing in Treasury inflation-protected securities, which are indexed to inflation to protect investors from its negative effects.
“These are a play on inflation coming back, and one could argue Trump is the king of inflation. These are not so bad to own right now,” says Gerber, who is the co-founder, president and chief executive of Gerber Kawasaki Wealth and Investment Management in Santa Monica, California.
Generally, TIPS, as with other U.S.-government backed securities, are regarded as a low-risk investment. The face value of TIPS typically rises with inflation, as measured by the Consumer Price Index, and they can be purchased through exchange-traded or mutual funds.
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J. Brent Everett, founder, chief investment officer and partner at Talis Advisors in Plano, Texas, agrees that TIPS are attractive but expresses that view for slightly different reasons.
“During periods of rising interest rates, bond portfolio managers typically target lower durations, less interest rate sensitivity. It’s certainly possible to do this with TIPS, as well,” Everett says.
“Keeping duration low and protecting against increases in unexpected inflation are not mutually exclusive,” he says.
“There are low-duration TIPS funds, and there are funds that protect against inflation in other ways,” Everett says.
For his clients’ portfolios, though, he prefers “combining nominal bonds or, for certain investors, tax-exempt bonds with inflation swaps.”
These investments offered better returns than the broader fixed-income world in recent years, but the risk/reward equation leans heavier on risk.
To evaluate the attractiveness of TIPS amid rising rates, advisors should first analyze why rates may rise, according to Bradford Long, the research director of global public markets for DiMeo Schneider & Associates of Chicago.
“The key point is what is the reason that interest rate are rising? If it because of inflation expectations, TIPS are likely to more attractive, but if it’s the Federal Reserve pushing up the curve, TIPS are less attractive,” Long says.
One trait about TIPS often causes confusion, he says.
“There is an interesting point here that is often misunderstood by market participants. The inflation protection is on the principle, rather than the coupon,” Long says.
A $1,000 investment in TIPS, with a coupon rate of 1% and no inflation means a $10 coupon payment. But if the inflation is 2%, the principle is adjusted according to $1,020, so, the coupon rate stays the same, but it is applied to the higher principal amount, making it $10.20.
“TIPS are still bonds. If interest rates are rising, TIPS bond prices are still falling,” Long says.
This story is part of a 30-30 series on evaluating fixed-income opportunities when rates are rising.
