Since these TIP securities are packaged as a stock, it is exposed to 'stock market risk'. That is the risk that irrational fools will oversell the security because they are over margined and need cash, That they are selling treasuries to buy stock based securities on todays bounce, or even that they are totally irrational and dont want to be in any stock any more, no matter how safe.
This market risk is exaggerated by the relative illequidity of the size of the market that these securities trade on.
If you are not willing to take these risks, then this is an inappropriate investment vehicle for you.
To me, if the treasuries are priced on the basis of 100 dollars share, then the current share price provides a discount to the underlying securities and so is a 'buy' pure and simple. That would be assuming that we are sure that the US government will honor the terms of the underlying securities.
If you feel that the US government is gonna default on these securities, than maybe you should not be in this index in the first place.
As far as any short term losses are concerned, you have not really lost any money until you sell.
I don't know how low is the downside, but I think I understand why it happened.
The principal amount of the security is adjusted for inflation, but the inflation-adjusted principal will not be paid until maturity. At maturity, the securities will be redeemed at the greater of their inflation-adjusted principal or par amount at original issue.
Suppose $100 bought a five-year note two years ago. After consecutive years of 5% CPI, your principal is $110. You might expect three more years of 5% inflation and an eventual redemption of approx $125. But now 5% deflation hits for the next three years. You'll get no interest and your principal will roll back to $100. I suppose you'd be willing to cut your loses and part with the note for $105 today.
But, since TIPS are fairly new, there's probably not much CPI-based adjustment baked into the principal. And it feels like we've rolled back most of it. Should deflation be less severe or shorter, the prices will respond positively.
"But now 5% deflation hits for the next three years. You'll get no interest and your principal will roll back to $100."
I dont t believe so.
You will never go back. You will not go up but never back.
You get interest but it does't incrase as it as it would with inflation.
So if the CPI is zero or negative,th evalue dosnt go up and the interest stays th esame.
This etf is slightly differnt. You have a person who trades them and is an expert at it.
With gold soaring, the Fed, and European central banks pouring billions of dollars into their financial systems, inflation has to be on the horizon. The Fed has made many statements in the past few months that the lowering of rates causes them to fear a rapid rise in inflation. However, the current credit freeze has caused the Fed to say that they will deal with inflation later, but their main concern now is to unfreeze the credit markets especially the commercial paper market. This bodes well for TIPS.
The risk of holding actual TIPS (from the US treasury) are minimal. You get your base coupon (0% to 2%, depending on the auction) plus the rate of inflation. If inflation is negative, TIPS are guaranteed to return your principal. The only real risk is if the US Government defaults.
Holding a TIPS ETF (like TIP), adds a different risk. Namely, the value of the TIPS do change do to supply and demand. If there is an expectation that the base rate will increase or inflation will decrease, then reduced demand for TIPS will reduce the market price of existing TIPS in circulation. This does affect the Net Asset value of the ETF and therefore will affect the price of the ETF.
I think what we are seeing now is increased expectations of deflation. Therefore, there is an increased expectation that TIP yield will trend toward 0%. 0% yield in a deflationary scenario isn't a bad thing, if you hold the actual TIPS bonds, but for the ETF, which has to compete with other fixed income products yielding something above 0% - well, it reduces demand for TIP, which leads to lower prices.
The key point is to recognize that the TIP ETF does not have identical risks to holding TIPS through the Treasury.
This is a good board and thanks for the quality info. I just averaged in my TIP holdings with a purchase today and am around 102 now. Worst case scenario, I take a 2 pt haircut plus whatever interest I make in a deflationary environment. Not a bad deal for a firm, southwest corner of any portfolio. I also have a little GLD for similar reasons, using the 'keep enuff on hand to bribe a border guard' theory.
I'm down 8% for the past 3 months (not including the distributions). As the recession takes hold over the next 12-18 months I can see TIPS funds go lower. However, once the recession is near the end and the Fed has to start raising rates, these will take off. If you can hold through the end of 2010, I would expect a maximum of 8% more to the downside (as long as there is no depression - even then 15% downside). But I think we will see 8 - 12% increases yearly after 2010 at least for the next 8 years. IMHO
Disclosure, I hold 30% of my portfolio in IPE, another TIPS ETF.
Don't forget to sell covered calls to reduce your basis. The downside is that the gain is capped. November 98 calls can be sold for $1.1. If TIP gets back over 100, the strike 98 calls would be in the money, then you roll Nov 98 to Dec 98 for a 50c or so credit, or roll Nov 98 to Dec 99 for even.
By selling covered calls, you can get 40-50c more per month. That's a nice 5-6% per year on top of the dividend.