TIPS Come of Age and Get a New Category

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The biggest surprise surrounding Morningstar's new inflation-protected bond category is just how long it took to populate.

There have been a handful of funds focusing on Treasury Inflation-Protected Securities almost since the day those U.S. government securities became available in the late 1990s. The very design of TIPS is so novel and so investor-friendly that some of us at Morningstar expected that investors would flock to them. The complexity that underlies the appeal of TIPS, however, was a deterrent to investors. Many stayed away, preferring to wait and see how they performed.

Institutional investors eventually began to come around, and individuals continue to grow more comfortable with TIPS. The growing number of TIPS funds--roughly 25 at last count--prompted us to create a separate category for them. (Morningstar also recently created new categories for long-short and target-maturity funds.)

The Basics

It's true that many of the details surrounding TIPS involve arcane bondspeak. But while similar bonds have been around overseas (Canada, the U.K., and Israel, in particular) for years, their very design is unique in the U.S. market.

What's so unusual about TIPS?

Like conventional bonds, TIPS pay a fixed rate of interest, expressed as a percentage of their face values. What makes them special, though, is that TIPS' face values are adjusted, in line with the government's consumer price index, between the time they're issued and when they mature. So while a TIPS issue may always carry a fixed rate of say, 3%, the amount of income it pays each year will be 3% of whatever its face value is at the time. (They pay interest semiannually, so the actual number will be slightly different.) The end result is that investors get an assurance that their principal will be indexed directly to the consumer price index. And by extension, their interest payments, while expressed as a fixed percentage, will be a fixed percentage of a principal amount that should move along with inflation.