A "Tip" for Fidelity Investors

11/06/2020 5:00 am EST

Focus: BONDS

John Bonnanzio

Editor, Fidelity Monitor & Insight

Here’s how crazy bond investing has been this year: With little inflation in view, Fidelity Inflation-Protected Index (FIPDX) has been among Fidelity’s top-performing taxable bond funds, asserts John Bonnanzio, editor of Fidelity Monitor & Insight.

Up 8.4% for the year through October 30 (that’s atop last year’s gain of 8.3%!), a combination of unprecedented demand and new issuances of conventional Treasuries and Treasury Inflation-Protected Securities — known as TIPS — drove their yields to record lows. Of course, that means their prices skyrocketed.

TIPS are considered a safe harbor investment. With bi-annual interest-rate adjustments, they’re designed to do what other fixed-rate bonds can’t do: protect against rising inflation. And as Treasuries, there’s essentially no credit risk. But that’s not saying there’s no risk.

With the economy crushed by Covid, most inflation pressures eased. However, some investors believed that the government’s unprecedented deficit spending and its monetary easing would fuel inflation.

With TIPS historically faring best when inflation expectations are rising, the rush to own them was on. But the real boost to TIPS came in the first half of the year; performance was turbocharged by Uncle Sam.

As part of the Federal Reserve’s asset protection program, the central bank bought about $134 billion in TIPS between mid-March and July.

So even though an important reason one might buy TIPS was absent — inflation —demand was overwhelming for government bonds. Action Recommendation While TIPS still have some legs, 2021’s gains are unlikely to match the past two years.

While a recovering economy and massive deficit spending are typically inflationary, technology disruption (see p. 1) and globalization remain powerful deflationary forces.

As for valuations, yes, TIPS (much like “regular” Treasuries) are no bargain. In fact, the real (after inflation) yield on 10-year TIPS is close to -1%!

However, with the so-called breakeven rate on 10-year TIPS and conventional Treasuries below the current inflation rate of 1.3% (that’s Social Security’s COLA for 2021), TIPS still make some sense to hold.

Not only will they protect against any surprise uptick in inflation, they may outperform fixed-rate bonds of the same maturity. Owing to its longer duration — or higher interest-rate risk — Fidelity Intermediate Treasury Index (FUAMX) has fared slightly better in recent years than Fidelity Inflation-Protected Index.

Looking to 2021, TIPS are pricey and have less upside potential. But we’re maintaining our OK to Buy rating on Fidelity Inflation-Protected Index as it still offers risk averse investors some upside potential and a hedge against the unexpected.

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