Somehow I own a fractional share of the Fidelity Inflation-Protected Bond Fund (FINPX) and so I get its annual and semi-annual reports. As I’ve noted before, the managers of this fund – William Irving and Franco Castagliuolo – are unusually frank in their ‘managers overview’ in each report. So their opinions perk my interest.

You can read the Sept. 30, 2012, report here.

TIPS have been an incredible investment over the last two years, combining safety with decent capital returns. This Fidelity fund, FINPX, has seen a year-to-date increase of 7.15% in net asset value. That nicely tops Vanguard’s Total Bond Market gain of 4.26% in net asset value. (Uh … I own the Total Bond Market, not FINPX, a decision I made at the perfectly wrong time of spring 2011.)

Below are some excerpts from their report, which I think lays out pretty well the positives and potential negatives of TIPS (fund) investing. On the one hand, we know that the Federal Reserve is committed to keeping interest rates very low in the near- and even mid-term future. And then there is the impending fiscal cliff, which in a worst-case scenario could cause deflationary pressures. Although the Fidelity managers don’t mention this, serious deflation would boost traditional Treasuries, but could ravage TIPS, which are an inflation-protection investment.

The one thing TIPS investors – especially those investing in funds like FINPX – might lose sleep over is a ‘miracle’ resolution of these problems, causing a stock market boom, employment growth, economic expansion. In those conditions, almost certainly, TIPS yields will rise, along with the overall Treasury market.

TIPS yields are sensationally low. Wildly low. Bubbly low. On the other hand the Federal Reserve presents a nice bodyguard for TIPS investors: Keeping rates ultra low by manipulating the Treasury market, while at the same time prompting inflationary fears, which in turn increases the attractiveness of TIPS.

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