Hot TIP for ETF Investors

Morgan Stanley (MWD Quote - Cramer on MWD - Stock Picks) has a few TIPS for exchange-traded fund investors.

The investment bank is out this week with a research note highlighting the pros and cons of the iShares Lehman TIPS Bond (TIP Quote - Cramer on TIP - Stock Picks) ETF, which tracks the well-known Treasury inflation protected securities, or TIPS. The report comes on the heels of rising worries about inflation.

TIPS are designed to protect investors from the erosion of purchasing power that rising inflation can cause. In an inflationary environment, TIPS tend to outperform most traditional fixed-income investments. TIPS pay a semiannual coupon, and their par value is adjusted to account for changes in the consumer price index.

The TIP exchange-traded fund is slightly different from the underlying bonds, however, in that it pays monthly income equal to its earned coupon income plus or minus any changes made to the par value of its holdings as a result of changes in the CPI.

Like all ETFs, the TIP trades very much like a stock, in this case on the NYSE. Options are available to be bought and sold on it as well. The expense ratio for the ETF is 0.20%.

"In light of recent commentary from the Federal Reserve Open Market Committee regarding increased worries about the inflation outlook, we believe it is appropriate to revisit the iShares Lehman TIPS fund," said Paul Mazzilli, ETF strategist at Morgan Stanley.

Prices rose 0.2% in November's CPI report, which was a less threatening pace than the 0.6% spike in October. Nevertheless, November's CPI reading was still 3.5% higher than a year ago, which is likely what prompted the Fed to issue its warning at its last meeting. The December CPI is set for release on Jan. 19.

In addition to the enhanced coupon payment based on the inflationary environment, Mazzilli points out that the TIP ETF should outperform traditional fixed-income investments during periods of rising interest rates.

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