Monday, October 27, 2008

TREASURY INFLATION PROTECTED BONDS (TIP)

I decided to add to an existing position in the ETF from Ishares that contains U.S. Treasury Inflation Protected Bonds (TIP), with a market order filled at 93.34.  The spread between the bid and ask was very narrow at the time the order was placed.  This security started October at almost 102. I read an article this morning from Morningstar that contended that hedge funds were liquidating this particular security due to yet another blow up in one of their many flawed strategies, which involved borrowing short term debt and buying the TIP.

With margin calls, Morningstar says the hedge funds are having to sell the TIP to repay the borrowed money.  The other concern is that deflation is more of a risk than inflation. The spread between a treasury security without inflation protection and the TIP is now less than 1% and has been bouncing near zero or lower than zero.  There is a chart linked in this Morningstar article that shows this spread. That means that an investor is paying very little to have the treasury bond with inflation protection compared to one without this protection. 

The expense ratio for this ETF is .2%. iShares Lehman TIPS Bond Fund (TIP): Overview It currently has 27 securities. It is my understanding that the state can not tax interest paid by the federal government. Consequently,  I do not pay Tennessee's 6% Hall Income Tax, which is a tax just on dividends and interest, for interest paid by the U.S. Government. 

 For those unfamiliar with how this works, the inflation protected securities are sold with a guaranteed yield that would be lower than a comparable treasury at the time of sale.  The principal of the TIP is adjusted up by the amount of the CPI but it can also be adjusted down for deflation.  The fixed rate is applied to the principal as adjusted, which will give the owner more interest during periods when the CPI is rising and less when it is falling. NYT I believe this adjustment of the principal to reflect CPI occurs semi-annually.  A drawback is stated in the following linked article from BusinessWeek Article, and it has to do with paying taxes on income not received, which makes these investments more appropriate in a retirement account. Safe Investing in a Troubled Economy The market data page at the Wall Street Journal has prices for individual treasury inflation protected securities. Markets Data Center - WSJ.com

Since I do not not know how long the TIP will be under selling pressure, I just took a nibble today.  While I view deflation as the most likely alternative for the near term, I am also concerned about the long term inflationary impact related to all of the new money creation. So I am not particularly concerned about the CPI falling over the next few months, due to my long term concern and particularly when I am paying just a little more for the inflation protection than without at the current prices.  

  I am not a financial advisor. In these posts, I am acting as an unpaid financial journalist and an occasional ornery political commentator.   I am also aggregating financial news stories that I view as important and providing any reader of these posts, assuming there are more than a couple, with links to those articles, sort of a filtered, somewhat intelligent, free search engine.  Any discussion made by me of particular securities  is not a recommendation to buy or to sell.  Trade at your own risk.  Consult with your financial advisor prior to making any purchase or sale. I will try to identify my sales too but it may take a few minutes after I implement them to create a post explaining my reasons.  The sale may before or after the post.  Before buying or selling any stock, even one recommended by a trusted financial advisor,  please research it and make up your own mind which is what I always try to do.  Research would include reading reports, reviewing financial records, earnings estimates, sec filings and prior earnings releases and news.  In this post, and all others by me, I am merely describing my reasons for purchasing  or selling securities, and the potential pitfalls that I identified prior to purchase or the reasons for a sale.  The securities mentioned in this and all posts written by me may not be suitable for others based on their unique financial position and risk profile.  Always read the prospectus before buying a Trust Certificate, bond, preferred stock or other bond or bond like investments.    


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