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Tips for Choosing a TIPS Fund

Tips for Choosing a TIPS Fund

Eric Jacobson: When it comes to choosing a TIPS fund, the story is a little paradoxical. That's because getting your arms around the underlying mechanics and movements of TIPS bonds can be pretty complex and daunting, but picking among TIPS mutual funds is actually pretty easy.

That's because TIPS are a lot like conventional Treasury bonds, which are very uniform and don't cost a lot to trade. And even though TIPS aren't as liquid as conventional Treasuries, they are pretty easy to trade compared with most other kinds of bonds. And in the case of TIPS, there are actually only 40 of them, and they average roughly $35 billion in issuance per bond. All in all, TIPS markets are pretty efficient overall, and managers running portfolios that are limited to TIPS generally have a hard time distinguishing themselves from one another without taking on an unusual amount of risk.

As a result, there are really only two ways to go if you want to be a standout TIPS offering. One is to supplement TIPS with additional market exposures to help add excess returns and distinguish yourself from plain-vanilla competitors and index funds. The other is to run portfolios close to or in line with indexes and charge as little as possible.

And when you look at favorite TIPS funds among Morningstar analysts, that split is pretty evident. The funds that our analysts rate most highly tend to either have very low expense ratios or have proven they can produce better returns than TIPS index offerings by taking on some--but not excessive--extra risk.

Two of our most highly rated picks are run by Vanguard. One is Vanguard Inflation Protected Securities, and the other is Vanguard Short-Term Inflation-Protected Securities Index Fund. Schwab offers a TIPS ETF that only charges 5 basis points and also gets one of our highest ratings.

On the other end of the spectrum is PIMCO Real Return. That fund charges well more than the average plain-vanilla or index offering, but it isn't overly expensive at the end of the day and benefits by supplementing a basic TIPS portfolio with other PIMCO bets designed to give the fund a leg up.

All in all, there are roughly 60 different TIPS funds out there, but only a handful really deserve your attention.

(Disclosure: Eric Jacobson owns shares in PRRIX, a different share class of PIMCO Real Return.)

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About the Author

Eric Jacobson

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Eric Jacobson is director of manager research, U.S. fixed-income strategies, for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He is a voting member of the Morningstar Medalist Ratings Committee for U.S. and international fixed-income strategies and shares responsibility for determining coverage and research priorities. Jacobson has focused on a variety of taxable, tax-exempt, and nontraditional fixed-income strategies, including several from asset managers such as Pimco, BlackRock, PGIM, and Guggenheim. He has also covered strategies from J.P. Morgan, Fidelity, Goldman Sachs, TCW, Vanguard, Loomis Sayles, Putnam, T. Rowe Price, American Century, Eaton Vance, FPA, and American Funds. He is the team's lead analyst on Pimco.

From 2006 through mid-2008, Jacobson was director of fixed-income strategies for Morningstar Indexes and was responsible for the design and launch of Morningstar's original suite of U.S., global, and emerging-markets bond indexes. Before assuming that role, he was a senior analyst, associate director, and fixed-income editorial director for the fund research team. Before joining the company in 1995 as a closed-end fund analyst, he worked for Kemper Financial Services.

Jacobson holds degrees in political science, Hebrew and Semitic studies, and integrated liberal studies from the University of Wisconsin.

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