Why Inflation-Protected Securities Could Underperform
New Year’s Resolution: Rethink Your Traditional Bond Portfolio (Part 4 of 5)
2. Given flat inflation, TIPS are less attractive
Since inflation is near flat, bonds designed to protect against loss of value to inflation might not be worth owning such as Treasury Inflation Protected Securities (or TIPS). Except in the longest maturities, in our view, they are expensive and we would keep them at a minimum in a portfolio.
Market Realist – Inflation-protected securities appear expensive
The graph above compares the yields for ten-year U.S. Treasury bonds (IEF) and the ten-year TIPS (TIP). Treasuries (TLT) have had higher yields compared to Treasury inflation-protected securities, or TIPS. The yields currently stand at 2.2 and 0.4, respectively. The only time TIPS yielded higher in the last ten years was in the middle of the financial (XLF) crisis, when investors were looking for safety and inflation was out of the question.
Currently, you have to pay a premium of close to 180 basis points over ten-year Treasury bonds to get a cover for inflation. Since inflation is holding steady, this may not be a good deal.
In search of yield, investors have upped the valuations of riskier assets like equities (SPY) and high yield bonds (JNK). The next part of this series explains why high yield bonds outperform when interest rates rise.
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