Duration of TIPS ETFs

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
JeanM
Posts: 37
Joined: Fri Jun 09, 2023 9:46 am

Duration of TIPS ETFs

Post by JeanM »

Every time I think I understand TIPS, I later realize that I don't. Please help me reconcile the following two statements in the context of TIPS ETFs (not individual TIPS bonds).

"Inflation and interest rates tend to move in the same direction."

"Inflation protection on 30-year TIPS and one-year TIPS is identical."

I realize interest rates and inflation rates are not the same thing. But if they tend to move in tandem, and if both of the above statements are true, does this suggest that an investor should hold shorter duration TIPS ETFs rather than intermediate or longer duration ones?

Source of first statement above: https://www.investopedia.com/ask/answer ... onship.asp

Source of second statement above: https://www.alliancebernstein.com/corpo ... 206-9-2024
dbr
Posts: 46716
Joined: Sun Mar 04, 2007 8:50 am

Re: Duration of TIPS ETFs

Post by dbr »

JeanM wrote: Sun Jun 09, 2024 9:09 am Every time I think I understand TIPS, I later realize that I don't. Please help me reconcile the following two statements in the context of TIPS ETFs (not individual TIPS bonds).

"Inflation and interest rates tend to move in the same direction."

"Inflation protection on 30-year TIPS and one-year TIPS is identical."

This statement means that any maturity of TIPS gets the same inflation indexed increase of face value. The definition of "inflation protection" is the contract to index the face value according to the specific steps documented at Treasury Direct. "Protection" in this context does not mean anything other than exactly what is specified in that contract. People can get very confused when they try to interpret "protection" using some generic concept. Complaining that there was not protection because the market price was affected by changes of interest rates or that the protection falls short on an after tax basis might be legitimate but is not what the contract is and therefore is a silly complaint.

I realize interest rates and inflation rates are not the same thing. But if they tend to move in tandem, and if both of the above statements are true, does this suggest that an investor should hold shorter duration TIPS ETFs rather than intermediate or longer duration ones?

It does if you want to minimize duration risk. For TIPS the risk is with respect to real rates. The Treasury Department only offers a guarantee to provide a fixed redemption value for savings bonds and not for Bill, Notes, Bonds, and TIPS. The offset to that is that most of the time the yield curve has substantial upward slope meaning longer durations also offer higher yield. Also, if your purpose is to set up an income ladder of TIPS the maturities are selected to construct the ladder.

alex_686
Posts: 13559
Joined: Mon Feb 09, 2015 1:39 pm

Re: Duration of TIPS ETFs

Post by alex_686 »

Nominal Rates = Expected Inflation + Real Rates

With TIPS you are just buy the Real Rates, or interest after inflation.

As such, you should purchase TIPS with the highest real rates that matches your Asset Allocation, where your AA matches your goals, risk tolerance, and market expectations.

Longer tenors offer greater certainty of the real rate you will earn. This isn’t the same thing as lower risk but it is adjacent.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
muffins14
Posts: 6052
Joined: Wed Oct 26, 2016 4:14 am
Location: New York

Re: Duration of TIPS ETFs

Post by muffins14 »

JeanM wrote: Sun Jun 09, 2024 9:09 am Every time I think I understand TIPS, I later realize that I don't. Please help me reconcile the following two statements in the context of TIPS ETFs (not individual TIPS bonds).

"Inflation and interest rates tend to move in the same direction."

"Inflation protection on 30-year TIPS and one-year TIPS is identical."

I realize interest rates and inflation rates are not the same thing. But if they tend to move in tandem, and if both of the above statements are true, does this suggest that an investor should hold shorter duration TIPS ETFs rather than intermediate or longer duration ones?

Source of first statement above: https://www.investopedia.com/ask/answer ... onship.asp

Source of second statement above: https://www.alliancebernstein.com/corpo ... 206-9-2024
Long term bonds lock in the coupon for longer time periods than short term bonds.

If you need money in 20 years you could buy
1) a 20 years tips paying 2% real every year
2) a 5 year tips now, and another one in 5 years etc etc. you have no idea what 5 year tips will be paying in 2029, so you are open to reinvestment risk. They could be paying 0% real, and choosing option 1 was the better option
Crom laughs at your Four Winds
Topic Author
JeanM
Posts: 37
Joined: Fri Jun 09, 2023 9:46 am

Re: Duration of TIPS ETFs

Post by JeanM »

I do thank you for your replies, but some seem to refer to individual TIPS bonds, whereas I am asking about TIPS ETFs.

Also, I neglected to mention that my goal is to earn a bond return that at least matches inflation. Is this a realistic goal? (FYI that I am not trying to generate a specific amount of income per year, nor am I trying to match income to future consumption.)
FactualFran
Posts: 2914
Joined: Sat Feb 21, 2015 1:29 pm

Re: Duration of TIPS ETFs

Post by FactualFran »

A TIPS ETF holds a set of individual TIPS. A TIPS ETF reflects the aggregate of effects on each of the individual holdings.

Inflation and nominal interest rates tend to move in the same direction. Whether inflation and real interest rates, such as the interest rate of TIPS, tend to move in the same direction is a different issue.

The rate of the inflation adjustment to the principal of TIPS is the same for all TIPS issues, regardless of the remaining term to maturity. For example, the inflation-adjusted principal of each TIPS issue will change at a non-annualized rate of 0.389% from the first day of June 2024 to the first day of July 2024.
dbr
Posts: 46716
Joined: Sun Mar 04, 2007 8:50 am

Re: Duration of TIPS ETFs

Post by dbr »

JeanM wrote: Sun Jun 09, 2024 9:07 pm Also, I neglected to mention that my goal is to earn a bond return that at least matches inflation. Is this a realistic goal? (FYI that I am not trying to generate a specific amount of income per year, nor am I trying to match income to future consumption.)
It is certainly possible for a TIPS or a TIPS fund to deliver a negative real yield over a particular period of time.
User avatar
jeffyscott
Posts: 13892
Joined: Tue Feb 27, 2007 8:12 am

Re: Duration of TIPS ETFs

Post by jeffyscott »

dbr wrote: Sun Jun 09, 2024 9:46 pm
JeanM wrote: Sun Jun 09, 2024 9:07 pm Also, I neglected to mention that my goal is to earn a bond return that at least matches inflation. Is this a realistic goal? (FYI that I am not trying to generate a specific amount of income per year, nor am I trying to match income to future consumption.)
It is certainly possible for a TIPS or a TIPS fund to deliver a negative real yield over a particular period of time.

But a TIPS bought now and held to maturity is guaranteed to earn about 2.2% above inflation.

A fund would be a collection of such bonds, so earning 0% real seems like a realistic and even conservative expectation over some reasonable time period with a fund at the moment, since real yields are more than 2% higher than that.
dbr
Posts: 46716
Joined: Sun Mar 04, 2007 8:50 am

Re: Duration of TIPS ETFs

Post by dbr »

jeffyscott wrote: Sun Jun 09, 2024 10:27 pm
dbr wrote: Sun Jun 09, 2024 9:46 pm
JeanM wrote: Sun Jun 09, 2024 9:07 pm Also, I neglected to mention that my goal is to earn a bond return that at least matches inflation. Is this a realistic goal? (FYI that I am not trying to generate a specific amount of income per year, nor am I trying to match income to future consumption.)
It is certainly possible for a TIPS or a TIPS fund to deliver a negative real yield over a particular period of time.

But a TIPS bought now and held to maturity is guaranteed to earn about 2.2% above inflation.

A fund would be a collection of such bonds, so earning 0% real seems like a realistic and even conservative expectation over some reasonable time period with a fund at the moment, since real yields are more than 2% higher than that.
Sure. But on the path to maturity there can be a loss. Over time not all TIPS can be had at positive real yield. After maturity there may not be TIPS to reinvest in that are at positive real YTM. Also if a large fraction of the return is in periodic coupon payments starting immediately the investor is then handed cash which is at loss to inflation until the investor can reinvest at positive real yield.

The problem here is that people like the OP just want a permanent universal guarantee that they can buy TIPS and meet or beat inflation without giving another thought to it and then when it turns out the deal depends on conditions that vary over time it looks like they can't have what they thought they were getting. This is the kind of possible disappointment that this forum is having to explain over and over again for investments that do in fact have a certain amount of complexity that undercuts over simplified assumptions.
User avatar
jeffyscott
Posts: 13892
Joined: Tue Feb 27, 2007 8:12 am

Re: Duration of TIPS ETFs

Post by jeffyscott »

^ Agree

Going back to the original question:
JeanM wrote: Sun Jun 09, 2024 9:09 am I realize interest rates and inflation rates are not the same thing. But if they tend to move in tandem, and if both of the above statements are true, does this suggest that an investor should hold shorter duration TIPS ETFs rather than intermediate or longer duration ones?
It is my understanding that Vanguard uses short term TIPS in their retirement funds because they respond more to inflation, rather than interest rate changes. I'm not sure if that reasoning is the same as what I quoted from the OP, but the conclusion is.

The Morningstar review of the Vanguard retirement series says:
The team prefers short-term Treasury Inflation-Protected Securities exposure because it provides a shorter-duration profile and purer inflation protection.
dbr
Posts: 46716
Joined: Sun Mar 04, 2007 8:50 am

Re: Duration of TIPS ETFs

Post by dbr »

jeffyscott wrote: Mon Jun 10, 2024 8:20 am
It is my understanding that Vanguard uses short term TIPS in their retirement funds because they respond more to inflation, rather than interest rate changes. I'm not sure if that reasoning is the same as what I quoted from the OP, but the conclusion is.

Because the duration is less the NAV will not change as much with interest rate changes as would a longer duration fund. On the other hand the indexing for inflation is the same for both. You could describe that as "respond more to inflation" but I think there is less chance for confusion if one is more explicit about what actually happens. Specifically one should not mistakenly conclude that longer TIPS are somehow less exactly indexed for inflation than short ones. But a lot of people have not understood that the NAV volatility is not removed because you have TIPS.

It would be a correct conclusion that if one wants to minimize volatility in the NAV due to interest rate changes then one buys the shortest duration. The ultimate would be I bonds. The cost for that is that under more typical circumstances is that the yield is less. Today the yield curve is fairly flat and nothing is gained by going longer as such. TIPS still yield more than I bonds, and for a time people were rushing to buy I bonds at 0.0% fixed rate, which is not so good.

As to the decision to use shorter TIPS in the TR funds, I think Vanguard has some sort of optimization model to devise an allocation for the funds and I don't know what the figure of merit for that is. One result is that the allocation to TIPS altogether is not a lot, and that seems odd on the face of it, but without a thorough discussion of how one wants to decide those things I can't see how we would know what is the best idea.
hudson
Posts: 7413
Joined: Fri Apr 06, 2007 9:15 am

Re: Duration of TIPS ETFs

Post by hudson »

JeanM wrote: Sun Jun 09, 2024 9:09 am Every time I think I understand TIPS, I later realize that I don't. Please help me reconcile the following two statements in the context of TIPS ETFs (not individual TIPS bonds).

"Inflation and interest rates tend to move in the same direction."

"Inflation protection on 30-year TIPS and one-year TIPS is identical."

I realize interest rates and inflation rates are not the same thing. But if they tend to move in tandem, and if both of the above statements are true, does this suggest that an investor should hold shorter duration TIPS ETFs rather than intermediate or longer duration ones?

Source of first statement above: https://www.investopedia.com/ask/answer ... onship.asp

Source of second statement above: https://www.alliancebernstein.com/corpo ... 206-9-2024
I wouldn't count on inflation and interest rates moving in the same direction.
I'd just duration match and take my profits or lumps.
I've never really understood TIPS funds, ETFs, or individual TIPS until I owned them for a while.
With SCHP, I really liked their monthly dividends.

Really understood? not really; I'm only an advanced novice with much to learn.
Post Reply