The Federal Reserve Board is expected to hike interest rates later this year as the economic recovery continues to build and inflation pressures increase — which means now is the right time to be in TIPS, right?
Not so fast, according to Dan Dektar, chief investment officer and senior portfolio manager at Smith Breeden Associates Inc., Chapel Hill, N.C., a firm that manages around $31 billion for institutions.
"If investors believe the Fed is going to take away the punch bowl" of low interest rates, "TIPS are the wrong place to be," he said.
Mr. Dektar said Fed tightening would be bad for Treasury inflation-protected securities because while the securities protect against upside inflation, they do not protect against higher real interest rates.
"People look at TIPS and say they're going to do great when inflation picks up," he explained. "I think people don't understand the real yield part. When the Fed becomes aggressive (raising interest rates), real yields will rise and the price of TIPS will fall."
In addition, Fed tightening will likely lead to lower inflation expectations.
Mr. Dektar said it makes sense for pension funds to use TIPS as part of broad asset diversification, but now is not necessarily the best time to be getting into them.
"It doesn't look like a good entry point," he said. "If you're concerned about an aggressive Federal Reserve, there will probably be better times to get in."