ETF Tips Fund

[eytonxav]

Recently I noticed a blurb in the newspaper talking about an ishares TIPS fund that had a very low expense (.22). Does this make sense as a way to have a diversified tips component in your portfolio vs a traditional tips mutual fund vs tips direct?

Doug

 

[Michael]

I would think that would depend upon how long you planned to hold the TIPS. Over the long term, treasury direct is much cheaper, but it is much easier to sell the IShare ETF than it is TIPS in the treasury direct account. In the latest issue of Barrons, Bill Gross recommended the IShare fund as a way to own TIPS for the short term. However, he tends to move in and out of TIPS and other bond investments according to which one he thinks will do well in the near future. TIPS can be very volatile in the short term depending upon which way real (inflation adjusted) interest rates move. If you plan to sell the TIPS when the economic evironment changes, the IShare ETF would be a much more convenient way to do this. The convenience will come at the cost of the expense ratio and broker's commission.

 

[wabmester]

Another minor thing to watch out for in a low-volume ETF like TIP is the delta from NAV. Go to ishares.com to find NAV info. TIP is currently selling at a slight premium to NAV. About $0.40 when I just looked at it -- a small amount, but it's larger than the expense ratio you're concerned about.

 

[eytonxav]

What about owning an index or fund vs a specific TIP issue, as I would assume the fund or index contains a spread of issues. Wouldn't the diversity provided through a fund or index be an advantage vs buying a single TIP direct (eg make a one time $50K investment)?

Doug

 

[wabmester]

Yes, a fund will give you a broad mix of coupons and maturities.   For the most part, however, I think a TIPS fund with average maturity X will perform like a single issue with maturity X.

The performance differences are pretty subtle.  If the fund holds high coupon issues, that will have a beneficial impact on duration.  And depending on the shape of the yield curve, an actively managed fund may be able to juice the yield by "riding the curve" and selling bonds before maturity.   I doubt whether these benefits would offset the extra cost of buying a fund, though.

It really comes down to whether you want the convenience of a fund or the cost savings of buying direct.

To put the cost in perspective, with a real yield of 2%, inflation at 2%, and a fund ER of 0.2%, you're giving up 5% of your return.

 

[cc]

Now that TIP has been trading for a while, does anyone have any further thoughts on it? I thought it might dip to a small discount to NAV when interest rates started up but no sign of that so far. Since the yield varies with inflation and they pay out the inflation component, I would expect the NAV to be pretty stable relative to other bond funds. So even a small discount could make it an attractive alternative to treasury-direct TIPS for short term holds...