TIPS Funds

A subpage of The U.S. Real Term Structure
by J. Huston McCulloch
Department of Economics, Ohio State University

On 6/29/00, the Vanguard Group launched a new Inflation-Protected Securities Fund (VIPSX). The minimum initial investment is $3,000 for a regular account, or $1,000 for an IRA or UGMA account. The expense ratio is 0.22% as of 1/31/03, in keeping with Vanguard's generally low management fees. By 3/31/03, it had grown to $3.6 billion in assets, roughly tripling in 12 months, and a 12-fold increase in 24 months.

Although the fund may, by its prospectus, hold up to 35% in non-indexed debt and/or derivatives, it is not at present holding anything but TIPS and spare change. On 3/31/01, its "average maturity" was given as 13.5 years, and its "average duration" as 2.7 years. (See below.) It reportedly has a 122% annual turnover rate.

American Century now offers an Inflation-Adjusted Treasury Fund, which is available to the general public, with a minimum initial investment of $2500. As of 5/2/02, it was holding $204 million in assets, up from $63.6 million one year prior. Its total annual expense ratio is .51%.

Pimco (Pacific Investment Management Co.) manages an additional institution-only Real Return Bond Fund. As of 12/31/01, it had $2.7 billion in assets, up from $893.6 million 9 months prior. Management fees are variously reported as 0.54 or 0.45%. It may be available to individuals as an option through participating employer plans.

The oldest, but smallest, indexed bond fund is the BHH Inflation Indexed Securities Fund, managed by Brown Brothers Harriman & Co, and formerly known as the 59 Wall St. Inflation-Indexed Securities Fund. This fund has been around since 1992, when it held a Government of Canada issue, but now it mostly holds TIPS, plus a few non-Treasury US inflation-indexed issues. On 3/31/02, it held $109 million in assets, up from $34.1 million 3 months prior. It has a .65% expense ratio, and reportedly a 321% annual turnover rate. According to a Fidelity webpage, this fund has a $100,000 minimum initial investment, far more than the $1000 - $3000 required by Vanguard.

The biggest inflation-linked fund of all is apparently that managed by Bridgewater Associates. As of 12/6/00, their page on Index-Linked Bond Research stated that they currently managed $4 billion in dedicated inflation-indexed bond portfolios. A 1999 Wall St. Journal article reported that their fund is "for large investors." In fact, it is so exclusive that their website doesn't even provide any further details about it! So unless you have several millions to park, it sounds like you had better stick with Vanguard, Fidelity, CREF, or direct holdings for now.

On July 9, 2002, Fidelity Investments opened its new Fidelity Inflation-Protected Bond Fund. According to the webpage, expenses are capped at 0.50%, although press coverage has suggested that they may in fact be higher. No data is available yet on size.

The CREF, American Century and 59 Wall St. funds currently hold all outstanding inflation-linked maturities. As this market develops, it would make good sense to me to offer in addition a series of funds, holding specific maturities, for the benefit of small investors targeting certain maturities for college or retirement. If they held only whole bonds, these would at present be limited to the two sectors 2007-2012, and 2028-2032. These funds would essentially just be dividend reinvestment plans. Investors could make regular small deposits through a sheltered or unsheltered payroll deduction. Most investors would probably opt for automatic reinvestment of coupons, though payouts would also be an option. These funds would invest in the most underpriced of the TIPS in their respective maturity sector, as determined by a term structure fitting method such as that used on this website. Because these funds would basically be on autopilot, management fees could be kept to a minimum, perhaps as small as 10 basis points with no load.

Note that American Century already offers a series of horizon-specific nominal bond mutual funds investing entirely in nominal zeroes of a common approximate maturity, in 5-year steps. As noted above, Barclays Capital recently stripped the first TIPS. As the market for these develops, a similar series of maturity-specific inflation-linked mutual funds will become feasible. They would be the ideal vehicle for investing for college, retirement, or other predictable future expenses, and would eliminate even the small coupon reinvestment risk that would be inherent in maturity-specific funds holding whole bonds, not to mention the considerable inflation risk in the American Century nominal funds.