(Dow Jones) While investors flock to Treasury Inflation-Protected Securities as an inflation cushion, some bond experts warn that they may not act as investors expect when consumer prices actually do start going up.
Principal and interest payments on TIPS are indexed to the government's consumer price index. In the last decade, they have outperformed many other bonds, but much of that performance has come from the drop in inflation and in yields-from 4% to about 1.5%. Like other bonds, prices rise when yields drop.
In an environment where inflation and yields are rising, TIPs will have trouble living up to their past and could prove more volatile. "Anybody looking backward at historical TIPS' performance is making a significant mistake if they're projecting that forward," said Rob Bloemker, head of fixed income at Putnam Investments. "It's not possible."
When inflation hits and TIPS don't perform as expected, investors may flee just as quickly as they rushed in, Bloemker said.
"I think the herd mentality, as much as it's been following positive performance, could also follow negative performance," he said. That disappointment could "exacerbate a sell-off," he said.
He noted that the Putnam Absolute Return 100 Fund now has no TIPS exposure. "We think they're too volatile for the return we're trying to generate over inflation."
Dan Shackelford, manager of the T. Rowe Price Inflation Protected Bond Fund, says investors shouldn't venture into TIPS without considering each of the securities' components.
"My concern is that people are focusing on the CPI component, and not paying attention to the fact that TIPS are bonds," he said. "A 10-year TIPS will act like a 10-year bond if interest rates go up"-that is, its price will do gown, he said.
Michael Pond, an interest-rate strategist at Barclays Capital, said, "Individual investors are coming into the TIPS market because they think they might do well if inflation moves higher. As an outright trade, we think that's the wrong one."
Pond does see "considerable value" in TIPS as inflation insurance relative to other fixed-income holdings. But investors should not be expecting a strong return if inflation rises, he said. They may simply do better than in other fixed-income funds.