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By Arijit Dutta | 10-08-2009 05:18 AM

Strong Case for TIPS in the 'New Normal'

PIMCO Real Return manager Mihir Worah says TIPS' explicit tie to the CPI index can help investors manage the unpredictability and volatility of inflation.

Arijit Dutta: Mihir, you've said elsewhere that TIPS are great hedging tools in this "new normal" economic and financial setting that we are in. Can you expand a little bit for our viewers on what the benefits of TIPS are at this time?

Mihir Worah: Sure. At PIMCO, what we call the "new normal" is essentially a regime of possibly low growth, high regulation, and high volatility in economic and financial variables.

And what you might find is that old relations that you could depend upon no longer hold in this new normal. And so the one big plus for TIPS in an inflation hedging program, is the fact that by contract they're one-for-one tied to the CPI index. TIPS prices or TIPS values will move one-for-one with what inflation does, no matter what volatility regime you're in.

And what happens is, in this new normal, as relationships break down, there are certain relationships that people believed, held, that equities would be a good hedge for inflation, real estate would be a good hedge for inflation. And clearly there are times when this might hold, for example, if you have modest inflation, it's likely that equity prices go up with modest inflation. Realistic prices go up.

However, one of the factors of the new normal is going to be the unpredictability, the volatility. Right now the market is grappling between deflation and hyper-inflation. If you have hyper-inflation, certainly equity prices are not going to do well. But TIPS prices will still go up one-for one.

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