Thinking Twice About Tips

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Investors poured $8.5 billion into Treasury Inflation-Protected Securities, or TIPS, funds in the second quarter, double the amount in the same period last year, according to researcher Strategic Insight. It’s easy to see why: When inflation rises, so does the face value of these bonds.

In this case, inflation is measured by the Consumer Price Index, better known as the CPI, a representative basket of goods and services purchased by Americans. But that calculation is precisely why some money managers are growing suspicious of TIPS. Many experts argue that inflation will show up in ways not reflected by the CPI.

“The CPI understates inflation,” says veteran value manager Charles de Vaulx, who runs $3.5 billion for money-management firm IVA and keeps a keen eye on economies around the world. He worries that the government’s burgeoning deficit will make foreign creditors jittery. As a result, they may demand more interest for the money they are loaning to the U.S., a form of inflation not reflected in the CPI.

Others take issue with the methodology used by the Bureau of Labor Statistics to calculate the CPI – for example, its decision to register a decline in price for newer computers that cost the same as an old version but offer more capabilities. That’s one reason independent economist John Williams, who runs Shadowstats.com, argues the CPI underestimates inflation’s true impact on Americans by as much as three to seven percentage points. That understatement could

be even worse for people who live in more expensive parts of the country and whose daily expenses can be as much as 30 percent higher, says Baton Rouge, La.-based financial planner Steven Stahler.

The BLS says its main goal is to calculate the change in what consumers need to spend to maintain a constant level of satisfaction. And the professionals are by no means ready to banish TIPS. “They aren’t perfect, but they have to be included,” says Mark Freeman, manager of the WHG Income Opportunity fund.

The key is to hold TIPS until maturity to avoid losing any principal. And it shouldn’t be an investor’s only inflation-fighting tactic. Commodities and stocks can often provide inflation protection, though there are more exotic options as well.

INFLATION PROTECTION

Some experts recommend that investors expand their fight against inflation beyond TIPS. Other steps:

Check the ingredients. When prices rise, it’s often a good idea to own the commodities (like corn, wheat, copper and gold) that are driving those price increases. Investors can get access to commodities through an exchange-traded fund or mutual fund.

Buy the sellers. As an investor, you want a firm to be able to raise prices during inflation so it maintains its profit margins. That’s why Portage, Mich.-based planner Charles Zhang likes companies that have strong brands and a competitive edge, offering products many cannot do without.

Short Uncle Sam. Advisers such as Dawn Bennett of Washington, D.C., suggest shorting, or betting against, Treasurys. One tactic is to sell short a 20-Year Treasury-bond ETF, a position that will rise when government bond prices fall.

2009 Copyright The New York Times Syndicate