Bryan Johanson, portfolio manager with C.S. McKee & Co., expects Treasury Inflation Protected Securities (TIPS) to move tighter by late October, when he predicts the Treasury to announce that it will stop issuing long term TIPS. Depending on the break-even inflation rate at that time, Johanson would consider selling his entire TIPS allocation, $104 million (8% of the portfolio), or reducing it to 5%, or $39 million. The inflation break-even is the difference in yields between nominal Treasuries and TIPS. If the break-even moves up to 1.80%, the firm will move to the 5% allocation. If the break-even goes above 2%, he will liquidate the entire holding to take profits. Right now, the break-even is at 1.56%.
Johanson says TIPS have not performed well because the rate of inflation has been falling in line with the economic slowdown. He argues the Treasury will stop issuing TIPS at some point because they are costly and because the Bush Administration may want to reverse a policy enacted under the previous administration. The firm is invested in 10-year TIPS because break-even levels are more attractive on the intermediate than on the long end of the curve, due to the relative flatness of the TIPS curve compared to the Treasury curve.
The Pittsburgh, Pa., firm has a $1.3 billion portfolio of taxable fixed-income assets. The allocation is 30% in mortgage pass-throughs, 26% in corporates, 13% in Treasuries, 12% in closed-end CMO funds, 8% in TIPS, 4% in asset-backed securities, 3% in Agencies debentures, 2% in cash and 2% in commercial mortgage-backed securities. The fund is neutral against its benchmark, the Lehman Brothers aggregate index, with a 4.62-year duration.
