TIPS' Time May Be Near

There are now about 20 mutual funds based on these securities, with a handful of new offerings in the works, and they are seen as the potentially least volatile hedge against inflation.

If predictions on inflation -- which was only 1.9% last year -- are on the money, TIPS are a smart bet, says John Hollyer, portfolio manager of the Vanguard Inflation-Protected Securities Fund. (VIPSX Quote) The $4.9 billion fund has a three-year return of 10.37%, a bit above the average return of funds tracked by Lipper of 10.07% for the period.

"The most important reason for people to buy TIPS is if they genuinely need protection from inflation, because the returns of TIPS tend not to be all that well correlated to other types of bonds," he says.

Since the securities' first issue in 1997, the TIPS market has grown to about $200 billion. Five of the oldest TIPS mutual funds tracked by Lipper had an average three-year return of 10.07%.

But the growth of the market has some advisers concerned that TIPS are morphing a bit, and that new investors should not expect that sort of performance, even if coupon payments rise with increased inflation.

"Many people -- and it is human nature -- project past experience into the future," Hollyer says. "There's this thinking that TIPS can't lose. I think that's erroneous. I think it's probably fair value now, as opposed to attractive value."

Martin Vostry, a research analyst with Lipper, says high demand for the securities may start squeezing the performance of TIPS funds.

"At this point, the high demand right now and not as much supply, means prices have been driven up, and so yields have been going down," he says. "But over the longer term, TIPS funds are pricing in inflation at 2.3% for the next 10 years. If inflation behaves as it has historically, that still provides a good deal for investors."