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TIPS ETFs and Negative Yields

tlydon@globaltrend.com (Tom Lydon)

Investors have been buying  Treasury Inflation Protected Securities, or TIPS, in recent auctions even though the bonds offer negative yields, because they want to hedge inflation risks.

The Treasury Department sold $13 billion in 10-year Treasury Inflation Protected Securities last week — the second time 10-year TIPS have sold with a negative yield. “Investors still buy them because besides the coupon, TIPS pay the rate of inflation,” MarketWatch reported last week. [ETF Spotlight: TIPS]

When individuals invest in TIPS, the bonds’ principal is hitched to changes in the Consumer Price Index. [Why TIPS ETFs Have Negative Yields]

ETFs in the category include iShares Barclays TIPS Bond Fund (NYSEArca: TIP), PIMCO 1-5 Year TIPS (NYSEArca: STPZ), SPDR Barclays Capital TIPS (NYSEArca: IPE) and Schwab U.S. TIPS (NYSEArca: SCHP).

Yields on TIPS ETFs have moved higher recently along with yields on regular Treasury bonds.

“It is important to note that inflation is just one component of interest rates and that changes in the ‘real rate’ or the risk-free cost of capital will cause the value of TIPS to oscillate up or down just like Treasury bonds,” Morningstar says in an analyst report on iShares Barclays TIPS Bond Fund. “It is also important to note that because of the inflation adjustment on TIPS, the yield you get today is not set in stone, and investors should be prepared for it to move up or down depending on the movements of the CPI.”

The so-called inflation break-even rate is currently around 2.4%. The rate is determined by comparing the 10-year Treasury bond yield with the 10-year TIPS yield.

If inflation averages more than the breakeven rate over the next decade, then investors would be better off owning TIPS than normal Treasury bonds. [ETF Chart of the Day: TIPS]