TIPS: Still A Bargain?

Heading into the second half of 2009, Treasury Inflation-Protected Securities have been a success story few probably imagined a year ago.

Inflation is still a source of debate. Indeed, many investors say they’re still more concerned about deflation. So from a near-term view, what is driving a dramatic reversal in fortunes in TIPS funds this year?

Consider the most popular exchange-traded fund in the group. That’s the iShares Barclays TIPS bond fund (NYSEArca: TIP). It has nearly doubled in size from a year ago, and now counts more than $15.3 billion in assets. Through the initial seven months of this year, investors had put $5.6 billion of net inflows into the fund—more than twice as much as the same time last year.

By comparison, the second-biggest bond ETF is the iShares iBoxx Investment Grade Corporate Bond Fund (NYSEArca: LQD). In that same period, it had attracted about $5.1 billion in net flows (vs. $765 million over the opening seven months of 2008). It was listed by the National Stock Exchange last month as the second-biggest bond ETF; it now has nearly $13 billion in assets.

To put things into perspective, the broad iShares Barclays Aggregate Bond Index Fund (NYSEArca: AGG) is third with some $10.2 billion. But that’s about the same level it was at this time last year.

Of course, corporate bonds have been on fire. LQD, for example, has returned more than 9% for its investors in the past 12-months. Compare that to TIP, which has negative total returns greater than 1% over that same period.

But TIP has mounted a comeback this year, up nearly 5% so far in 2009. The other ETF focused on U.S. TIPS, the SPDR Barclays TIPS (NYSEArca: IPE), has rebounded even more strongly. In the past 12 months, it still is down by more than 1%; since Jan. 1, however, IPE has returned more than 6%.

LQD remains hot, up better than 6%. (The broad-market AGG has gained less than 2% this year.)

At the same time, conventional government long-bond ETFs have suffered in 2009, with the iShares Barclays 20+ Year Treasury bond fund (NYSEArca: TLT) down by more than 17%.

Below is a table showing the changes in conventional (fixed-rate) U.S. Treasury yields year-to-date.

Conventional U.S. Government Bond Yields 12/29/08 (%) 8/26/09 (%) Change (bp)
2 year 0.74 1.06 32
5 year 1.46 2.45 99
10 year 2.08 3.45 137
30 year 2.58 4.21 163

Source: Financial Times data

Yields have risen at all maturities, but disproportionately for longer-dated bonds, causing the heaviest losses for investors in the long end of the yield curve, since the price sensitivity to interest rate changes is greatest there.

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