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Are TIPS the way to whip inflation now?
Still a relatively young type of bond, Treasury inflation-protected securities have held up well in facing their first bout of real inflation. The average TIPS mutual fund surged 4.81% in the first quarter, more than twice the gain of the Lehman Bros. Aggregate Bond Index.
And with higher inflation almost guaranteed by soaring gasoline prices and the plummeting value of the dollar, TIPS look like a wonderful place to put your money.
But they're not. Not now.
TIPS were a great idea a year ago because inflation has been rising ever since. They've advanced 12.6% as the Consumer Price Index has accelerated to a 4% annual rate of inflation from 2%.
But with the United States in recession and the global economy slowing markedly, will inflation be higher one year from now? Almost certainly not.
"U.S. Treasurys are the richest asset in the world right now, and these are the second-richest," says Mihir P. Worah, the manager of Pimco Real Return (PRTNX), one of the largest investors in TIPS. "The real yield on two-year TIPS is negative; after inflation, you'll get less money back than you bought them for."
Pimco, by far the largest and most-respected bond-investment company, has been downplaying TIPS for months. "We are looking into high-quality agency mortgages -- Fannie Mae (FNM, news, msgs) and Freddie Mac (FRE, news, msgs)," says Worah, who took over the TIPS fund at the end of last year. "We're also starting to step into very-high-quality corporate bonds, (including) banks too big to fail, like Citibank (C, news, msgs)."
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But when inflation fears begin to recede in the face of recession, Worah advises, TIPS will become very attractive once more. "Longer term, we certainly are setting up for inflation," he warns.
So there will come a time to buy TIPS bonds once again, but that time is not now. It will come when recession has tamed inflation enough that the bonds' prices have gone down.
Safe choices mean falling yields
Worah is one of what Pimco calls its rocket scientists -- computer jockeys who design complicated mathematical models to discover the risk buried inside financial derivatives. The subprime meltdown has left Pimco relatively unscathed, thanks to the ability of the company's computer wizards to tease out vulnerabilities others did not discover.In Worah's case, the term is especially apt. He has a doctorate in theoretical physics and joined Pimco seven years ago from the Stanford Linear Accelerator Center, where he was studying antimatter.
(So in addition to knowing bonds, he can speak reassuringly about the Large Hadron Collider, an enormous particle accelerator being built in Europe, which some skeptics fear could create a black hole that will devour the Earth. "The black holes it could create are virtual," Worah says. "You need such high luminosity to create them. You cannot create real black holes at the intensities that the Large Hadron Collider would have.")
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It doesn't take a doctorate, however, to know that when bond yields fall, their prices rise. That math is as elementary as it is inflexible, required to keep the principal value in line with the coupon.
So as Treasury yields have fallen, Treasurys have gotten expensive. A 10-year Treasury note that yielded 4.75% one year ago yields 3.49% today. Its price, therefore, has gone from $100 to $110.61 -- a double-digit percentage increase.
Continued: 'Real return' bonds
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