Vanguard's long-term outlook for TIPS

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simplesauce
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Vanguard's long-term outlook for TIPS

Post by simplesauce » Sat Oct 07, 2017 12:34 pm

I have half of my bond holdings in TIPS (as suggested by David Swensen.) However, I have read many articles questioning the usefulness and capabilities of TIPS. And I have been concerned about having such a large stake in my portfolio.

Furthermore, Vanguard just sent out an email that concludes:

"While a combination of materially stronger global growth and accommodative monetary policies could drive up inflation over the medium term, that's not the most likely outcome in our view. We expect long-term structural forces (including technology) will result in the United States and many other economies struggling at times to achieve sustainable inflation rates of 2% or more."

Thoughts on the long-term case for TIPS?

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Re: Vanguard's long-term outlook for TIPS

Post by VinhoVerde » Sat Oct 07, 2017 1:10 pm

I have half of my fixed income assets in individual Tips that mature every 5 years until I reach 90. Currently, I'm 64 and the first 100K mature when I'm 70 and every 5 years thereafter.
Tips are useful for an "unexpected" rise in inflation. Though Vanguard's opinion is that over the medium term this is unlikely it is by no means impossible. In other words, that's what Tips are for.
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Re: Vanguard's long-term outlook for TIPS

Post by drzzzzz » Sat Oct 07, 2017 1:44 pm

I got the impression from talking with a Vanguard Personal advisory rep awhile back that they are suggesting more corporate, intermediate, and total bond funds in an allocation appropriate for you and not to include TIPS, but to let your stock portfolio be the inflation hedge.

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Re: Vanguard's long-term outlook for TIPS

Post by simplesauce » Sat Oct 07, 2017 1:56 pm

drzzzzz wrote:
Sat Oct 07, 2017 1:44 pm
I got the impression from talking with a Vanguard Personal advisory rep awhile back that they are suggesting more corporate, intermediate, and total bond funds in an allocation appropriate for you and not to include TIPS, but to let your stock portfolio be the inflation hedge.
Right. Are TIPS no longer necessary?

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Re: Vanguard's long-term outlook for TIPS

Post by Beardog » Sat Oct 07, 2017 2:17 pm

At 55 years old, I am a 60/40 kind of guy. I long ago set the goal of keeping 50% of my bond holdings in Vanguard Total Bond, and 50% in Vanguard TIPS. A year or two ago, because of some changes beyond my control in one of my tax deferred plans, my TIPS allocation dropped about 15% below my allocation goal (and Total Bond Market holdings went up by the same percentage). Rather than sell a large chunk of Total Bond Market shares to balance back, I chose to just start buying 100% TIPS shares each time that I made a contribution.

I must admit that buying TIPS shares every month through this recent market is/has been boring (and adverse to my human nature), especially when I know that I am "losing" a little money every day in so doing. Most of my holdings are now with Vanguard, and with my Individual 401(k), the plan doesn't allow automatic bank investment draws. So, I have to log in every month and initiate a draw from my checking account into my 401(k). That sometimes makes it even harder to buy TIPS, while I am sitting there looking at all that red ink and those downward pointing red arrows! But, I am staying the course, because NOBODY in a human body knows what the future holds, I sleep well, and my IPS says stay the course! Plus, I am still at 60/40 overall, I just have a few percentage points more in Total Bond Market shares.

Almost every "expert", Vanguard included, has new, updated advice every week or every few months, but most of that advice is highly biased towards recency, combined with the human tendency to think we(they) can predict the future better today than we(they) could at some point in the past.
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Re: Vanguard's long-term outlook for TIPS

Post by jalbert » Sat Oct 07, 2017 2:49 pm

simplesauce wrote:
Sat Oct 07, 2017 12:34 pm
I have half of my bond holdings in TIPS (as suggested by David Swensen.) However, I have read many articles questioning the usefulness and capabilities of TIPS. And I have been concerned about having such a large stake in my portfolio.

Furthermore, Vanguard just sent out an email that concludes:

"While a combination of materially stronger global growth and accommodative monetary policies could drive up inflation over the medium term, that's not the most likely outcome in our view. We expect long-term structural forces (including technology) will result in the United States and many other economies struggling at times to achieve sustainable inflation rates of 2% or more."

Thoughts on the long-term case for TIPS?
First, Swensen's bond portfolio recommendation is more specific than his just recommending half of your bonds in TIPs. He specifically recommends allocating bonds as 50% TIPs and 50% nominal treasuries. If you hold, say, 50% TIPs and 50% Total Bond Index, then you are not aligned with his recommendation. The risk management capabilities of the latter are different. Swensen's recommendation is part of an overall portfolio that takes more risk on the equity side (eg equities tilted to EM, relatively high REIT allocation) while trying to maximize the risk mitigation capability of the bond holdings.

Second, instead of considering Vanguard's expected inflation projection, you could consider the entire market's expected inflation projection. Compensation for that is already (probabilisticly) priced into nominal treasuries. TIPs help you when inflation exceeds the aggregate expectations of the market. If expectations for inflation are low, there may not be alot of perceived drivers of inflation, but also that is not a high bar for TIPs to overcome. When inflation expectations are high, lots of drivers of inflation are presenting themselves, but high inflation expectations are also priced into nominal treasuries in their yield, and the higher expected inflation is a higher bar for TIPs to overcome.
Last edited by jalbert on Sat Oct 07, 2017 6:11 pm, edited 1 time in total.
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Re: Vanguard's long-term outlook for TIPS

Post by baw703916 » Sat Oct 07, 2017 3:11 pm

TIPS are less risky than nominal Treasuries of the same duration: specifically, they avoid inflation risk. So according to MPT, the market should price them to have a lower expected return in the long run. So investing in TIPS, all else being equal, is likely to decrease your portfolio value down the road. OTOH, it will protect your portfolio from having its value eroded should we experience high inflation.

Now why does Vanguard appear not to be recommending them, and why has Swenson recommended them? They have their reasons. It's appropriate for each individual to consider how sensitive to inflation their particular situation is, and allocate (or not) to TIPS accordingly.

Saying the outlooks for inflation is X and therefore TIPS are/aren't a good investment sounds like market timing to me. Yes, even if it's Vanguard who's saying that!
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Re: Vanguard's long-term outlook for TIPS

Post by rrppve » Sat Oct 07, 2017 3:12 pm

TIPS make a ton of sense, especially for those in or near retirement. Inflation is a real risk that TIPS provide real immunization against.
Don't know why anybody would bother following Vanguard's fixed income advice. Weren't they recommending an allocation to International Bonds when it was clear that at current prices and yields domestic bonds were a far better investment. Their diversification argument never made any sense to me on that point. I'd much rather own TIPS than international bonds.

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Re: Vanguard's long-term outlook for TIPS

Post by arcticpineapplecorp. » Sat Oct 07, 2017 3:17 pm

FWIW, this Rick Ferri article recommended TIPS be 20% of one's fixed income, not 50%:

https://portfoliosolutions.com/latest-l ... /tips-tips
Last edited by arcticpineapplecorp. on Sat Oct 07, 2017 3:18 pm, edited 1 time in total.
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Re: Vanguard's long-term outlook for TIPS

Post by grok87 » Sat Oct 07, 2017 3:18 pm

simplesauce wrote:
Sat Oct 07, 2017 12:34 pm
I have half of my bond holdings in TIPS (as suggested by David Swensen.) However, I have read many articles questioning the usefulness and capabilities of TIPS. And I have been concerned about having such a large stake in my portfolio.

Furthermore, Vanguard just sent out an email that concludes:

"While a combination of materially stronger global growth and accommodative monetary policies could drive up inflation over the medium term, that's not the most likely outcome in our view. We expect long-term structural forces (including technology) will result in the United States and many other economies struggling at times to achieve sustainable inflation rates of 2% or more."

Thoughts on the long-term case for TIPS?
A few thoughts on Vanguard's view of TIPS:

1) TIPS Market size:
The size of tips markets is $1.7 Trillion =about 1/20th of the Aggregate Bond Market (i.e. Vanguard Bond Market index which does not include TIPs). See here for a reference- page 7. https://www.nuveen.com/Home/Documents/D ... leId=56370

At $4 Trillion in assets Vanguard is, IMHO, increasingly being forced in both its investing actions and its general investing guidance toward the broadest possible of world assets: Total Stock Index, Total International Stock index, Total Bond index, Total International Bond index etc.

For example if they told everyone that they should have 10% in TIPs, that is potentially $400 Billion or 25% of the TIPS market. That would have an incredibly distorting effect on the TIPS market. Consequently, Vanguard is NOT going to make that recommendation.

2) Vanguard may be right that inflation may struggle to get to 2%. But luckily that is how tips are currently priced. 10 year break-even inflation is 1.88% and 30 year breakeven inflation is 1.94%. So one is not paying any or much of an insurance premium to protect against the possibility of a return to a high inflation era like the 1970s.

3) Vanguard's Technology argument seems weak and tendentious. Technology is always disruptive but its hard to say if it is any more disruptive now than it was in say the 50s/60s/70s. Before the high inflation of the 70s, inflation was quite low in the 50s and 60s. My crystal ball is cloudy. Low inflation now doesn't mean high inflation can't spring up unexpectedly like it did in the 70s (there is an argument that it may have been related to the vietnam war spending).

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Re: Vanguard's long-term outlook for TIPS

Post by grok87 » Sat Oct 07, 2017 3:19 pm

simplesauce wrote:
Sat Oct 07, 2017 1:56 pm
drzzzzz wrote:
Sat Oct 07, 2017 1:44 pm
I got the impression from talking with a Vanguard Personal advisory rep awhile back that they are suggesting more corporate, intermediate, and total bond funds in an allocation appropriate for you and not to include TIPS, but to let your stock portfolio be the inflation hedge.
Right. Are TIPS no longer necessary?
The problem is a stagflation scenario like the late 70s and early 80s. Stocks don't always do well in an inflationary enviroment.
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Re: Vanguard's long-term outlook for TIPS

Post by grok87 » Sat Oct 07, 2017 3:21 pm

baw703916 wrote:
Sat Oct 07, 2017 3:11 pm
TIPS are less risky than nominal Treasuries of the same duration: specifically, they avoid inflation risk. So according to MPT, the market should price them to have a lower expected return in the long run. So investing in TIPS, all else being equal, is likely to decrease your portfolio value down the road. OTOH, it will protect your portfolio from having its value eroded should we experience high inflation.

Now why does Vanguard appear not to be recommending them, and why has Swenson recommended them? They have their reasons. It's appropriate for each individual to consider how sensitive to inflation their particular situation is, and allocate (or not) to TIPS accordingly.

Saying the outlooks for inflation is X and therefore TIPS are/aren't a good investment sounds like market timing to me. Yes, even if it's Vanguard who's saying that!
agree but the other factor is liquidity. TIPS are less liquid that nominal treasuries so based on that factor they should have higher returns.
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Re: Vanguard's long-term outlook for TIPS

Post by Doc » Sat Oct 07, 2017 4:05 pm

Q: What are you trying to achieve?

If you want an inflation adjusted LMP then maybe a long term TIPS ladder is appropriate. But it's very expensive. One percent real at 30 years? In Swedroe's bond book he made a TIPS as a percent of Treasuries recommendation. It was 100% at 3% real and 0% at 2% real. The chart was based on historic real rates for a ten not a thirty.

If you are worried about inflation in the short term well OK but nobody is concerned about short term inflation.

Do you want your Treasuries to be useful in a flight to quality situation. TIPS didn't do that job very well in '08.

Is you portfolio without TIPS big enough to give you a comfortable living at a 4% return. Would it still be adequate if you had a large part of it paying 1% real?

I break up our FI portfolio into its pieces for tax reasons. Of the amount allocated to Treasury only funds or notes about 1/6 is in TIPS but half of that has a 2% coupon.

If inflation starts to look like it may be a real concern in the future I think we will have plenty of warning and there will be time to add TIPS then as needed. Right now the Fed can't even get inflation to its target.
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Re: Vanguard's long-term outlook for TIPS

Post by columbia » Sat Oct 07, 2017 6:45 pm

Right now, the outlook looks pretty unappealing:

https://www.treasury.gov/resource-cente ... =realyield

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Re: Vanguard's long-term outlook for TIPS

Post by abuss368 » Sat Oct 07, 2017 7:19 pm

simplesauce wrote:
Sat Oct 07, 2017 12:34 pm
I have half of my bond holdings in TIPS (as suggested by David Swensen.) However, I have read many articles questioning the usefulness and capabilities of TIPS. And I have been concerned about having such a large stake in my portfolio.

Furthermore, Vanguard just sent out an email that concludes:

"While a combination of materially stronger global growth and accommodative monetary policies could drive up inflation over the medium term, that's not the most likely outcome in our view. We expect long-term structural forces (including technology) will result in the United States and many other economies struggling at times to achieve sustainable inflation rates of 2% or more."

Thoughts on the long-term case for TIPS?
We removed the Vanguards TIPS fund many years ago and focused on simplicity with only Total Bond Index. In hindsight this was a good move.

Taylor has a post noting he no longer has TIPS and has focused on simplicity with only Total Bond I believe.
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Re: Vanguard's long-term outlook for TIPS

Post by abuss368 » Sat Oct 07, 2017 7:20 pm

drzzzzz wrote:
Sat Oct 07, 2017 1:44 pm
I got the impression from talking with a Vanguard Personal advisory rep awhile back that they are suggesting more corporate, intermediate, and total bond funds in an allocation appropriate for you and not to include TIPS, but to let your stock portfolio be the inflation hedge.
This was my understanding but also they recommend Total International Bond Index.
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Re: Vanguard's long-term outlook for TIPS

Post by drzzzzz » Sat Oct 07, 2017 7:42 pm

You are correct they are also pushing international bonds as part of the bond portfolio - which i am not a fan of, but when discussing this with them, we asked for it to be as small a percentage of our total bond allocation as possible (not sure it really impacts much either way with bond yields being so low and thought I would see what their recommendation was and what would happen with international bonds since it's a new category for us).

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Re: Vanguard's long-term outlook for TIPS

Post by triceratop » Sat Oct 07, 2017 7:57 pm

rrppve wrote:
Sat Oct 07, 2017 3:12 pm
TIPS make a ton of sense, especially for those in or near retirement. Inflation is a real risk that TIPS provide real immunization against.
Don't know why anybody would bother following Vanguard's fixed income advice. Weren't they recommending an allocation to International Bonds when it was clear that at current prices and yields domestic bonds were a far better investment. Their diversification argument never made any sense to me on that point. I'd much rather own TIPS than international bonds.
On what do you base the superior expected returns of owning hedged international bonds? Is it just the yield in issued currency?
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Re: Vanguard's long-term outlook for TIPS

Post by whodidntante » Sat Oct 07, 2017 8:05 pm

If I-bonds are returning 1.96% and we have inflation why are TIPS losing money?

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Re: Vanguard's long-term outlook for TIPS

Post by Dandy » Sat Oct 07, 2017 8:11 pm

I have a modest allocation to the TIPS fund. I guess what seems to be "different this time" with inflation is a lack of population growth in many developed countries and the astounding potential of automation as a job reducer or pay reducer. This to go along with difficult pricing power when it so easy to compare prices on line.

In the past every advancement that reduced a job e.g. the classic blacksmith servicing the horse and buggy job loss was more than offset by the auto assembly line. Will self driving vehicles put truck, bus, taxi and uber drivers out of work? And they will do what? install solar panels?

It should be interesting and challenging - hope we have the ideas and leadership that are up to the challenge.

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Re: Vanguard's long-term outlook for TIPS

Post by siamond » Sat Oct 07, 2017 8:31 pm

drzzzzz wrote:
Sat Oct 07, 2017 1:44 pm
I got the impression from talking with a Vanguard Personal advisory rep awhile back that they are suggesting more corporate, intermediate, and total bond funds in an allocation appropriate for you and not to include TIPS, but to let your stock portfolio be the inflation hedge.
That is exactly what I decided to do a few years back. Nothing to do with Vanguard's advice, the key influencer was the wonderful e-book from Dr. Bernstein "Deep Risk". Everything I've read since then, and everything I've seen about TIPS funds erratic past history reinforced me in my approach.

This being said, if somebody has a lot of bonds in their AA (which isn't my case), then it may make more sense to get a good chunk of TIPS in there. Regular bonds can be absolutely devastated by inflation, that is for sure.

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Re: Vanguard's long-term outlook for TIPS

Post by Phineas J. Whoopee » Sat Oct 07, 2017 9:02 pm

Hi simplesauce.

This has always been my suggestion regarding including a significant portion of inflation-protected fixed income in one's bond allocation, and it has nothing to do with what I think inflation will or won't be, nor whether nominal corporates will have higher nominal returns than TIPS over any particular period of time.

Evaluate how badly high inflation would hurt you and your family, should it occur. If it won't be very bad, like if you're living on a CPI-adjusted pension, then the argument for inflation-protected fixed income is weak. If it would be especially bad, the argument is strong.

I'm suggesting evaluating the magnitude of the risk, not its likelihood.

In my own case I concluded inflation is the largest single financial risk I face. 40% of my portfolio is inflation-indexed, and another 40% is in equities.

I do not present my asset allocation as appropriate for everybody. It's very much based on my own personal circumstances.

With respect to my portfolio and beyond, I view my role as being a risk manager, not a return maximizer.

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Re: Vanguard's long-term outlook for TIPS

Post by FIREchief » Sun Oct 08, 2017 1:13 am

Doc wrote:
Sat Oct 07, 2017 4:05 pm
In Swedroe's bond book he made a TIPS as a percent of Treasuries recommendation. It was 100% at 3% real and 0% at 2% real.
Well this just sounds plain silly. If you can get 2% guaranteed real return in a US treasury, you should walk away?? Really?
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Re: Vanguard's long-term outlook for TIPS

Post by grok87 » Sun Oct 08, 2017 3:03 am

Phineas J. Whoopee wrote:
Sat Oct 07, 2017 9:02 pm

With respect to my portfolio and beyond, I view my role as being a risk manager, not a return maximizer.

PJW
Amen to that.
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Re: Vanguard's long-term outlook for TIPS

Post by grok87 » Sun Oct 08, 2017 3:18 am

abuss368 wrote:
Sat Oct 07, 2017 7:19 pm
simplesauce wrote:
Sat Oct 07, 2017 12:34 pm
I have half of my bond holdings in TIPS (as suggested by David Swensen.) However, I have read many articles questioning the usefulness and capabilities of TIPS. And I have been concerned about having such a large stake in my portfolio.

Furthermore, Vanguard just sent out an email that concludes:

"While a combination of materially stronger global growth and accommodative monetary policies could drive up inflation over the medium term, that's not the most likely outcome in our view. We expect long-term structural forces (including technology) will result in the United States and many other economies struggling at times to achieve sustainable inflation rates of 2% or more."

Thoughts on the long-term case for TIPS?
We removed the Vanguards TIPS fund many years ago and focused on simplicity with only Total Bond Index. In hindsight this was a good move.

Taylor has a post noting he no longer has TIPS and has focused on simplicity with only Total Bond I believe.
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Re: Vanguard's long-term outlook for TIPS

Post by Doc » Sun Oct 08, 2017 6:59 am

FIREchief wrote:
Sun Oct 08, 2017 1:13 am
Doc wrote:
Sat Oct 07, 2017 4:05 pm
In Swedroe's bond book he made a TIPS as a percent of Treasuries recommendation. It was 100% at 3% real and 0% at 2% real.
Well this just sounds plain silly. If you can get 2% guaranteed real return in a US treasury, you should walk away?? Really?
You are also getting that same 2% real on a nominal note just without the guarantee that has a cost premium associated with it. I'm not trying to justify Swedroe's numbers just pointing out that the market has changed drastically since then.

Personally I won't buy a note longer than 7 or 8 with today's yield curve - nominal or inflation indexed.
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Re: Vanguard's long-term outlook for TIPS

Post by BigJohn » Sun Oct 08, 2017 7:03 am

Phineas J. Whoopee wrote:
Sat Oct 07, 2017 9:02 pm
With respect to my portfolio and beyond, I view my role as being a risk manager, not a return maximizer.
Along these lines, I view TIPS as insurance against an inflation surprise. Like all insurance, you usually hope you'll never need it and there is always a cost. Only you can decide if the cost of the insurance is commensurate with the uninsured risk. I'm 3 years into retirement and the decision I made was that I wanted additional insurance against unexpected high inflation. Having a stock allocation could help in some but not all scenarios so I decided to move some of my bond allocation to TIPS.

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Re: Vanguard's long-term outlook for TIPS

Post by in_reality » Sun Oct 08, 2017 7:19 am

triceratop wrote:
Sat Oct 07, 2017 7:57 pm
rrppve wrote:
Sat Oct 07, 2017 3:12 pm
TIPS make a ton of sense, especially for those in or near retirement. Inflation is a real risk that TIPS provide real immunization against.
Don't know why anybody would bother following Vanguard's fixed income advice. Weren't they recommending an allocation to International Bonds when it was clear that at current prices and yields domestic bonds were a far better investment. Their diversification argument never made any sense to me on that point. I'd much rather own TIPS than international bonds.
On what do you base the superior expected returns of owning hedged international bonds? Is it just the yield in issued currency?
I think rrppve is saying that current yields make domestic bonds clearly better.

Actually, Vanguard is saying that the expected return is exactly the same. That an investor should be indifferent because there is a hedge return component which makes them the same.

The diversification benefit then is 1) less trouble if the US defaults [which might be temporarily possible in a budget fight] and more importantly 2) more safety from interest rates hikes because it's unlikely to happen everywhere simultaneously meaning you'll have bonds that haven't suffered NAV loss even if it happens someplace.

The hedge return is real and you will definitely earn it. The question I have is that since it's based on short term rate differentials, how do you earn a term premium. I mean what if the US had a persistently higher sloping yield curve. In such a scenario the international bonds would underperform as the short term hedge return wouldn't cover the bigger rate difference down the yield curve.

Maybe there is an economic reason why the US couldn't maintain a higher sloping yield curve though. (and remember we are talking mostly developed countries in the Vanguard fund- obviously faster growing emerging markets likely will see periods of higher inflations and steeper curves).

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Re: Vanguard's long-term outlook for TIPS

Post by #Cruncher » Sun Oct 08, 2017 7:41 am

baw703916 wrote:
Sat Oct 07, 2017 3:11 pm
TIPS are less risky than nominal Treasuries of the same duration: specifically, they avoid inflation risk.
This is key. If one believes in "taking the risk on the equity side", then TIPS are the logical choice for the bond side of one's portfolio. 100% would be appropriate. I've never understood the argument often made on this forum that one should only own TIPS if they are "necessary"; i.e., if one is especially vulnerable to inflation risk. You never hear it argued that one should only invest in nominal Treasuries (as opposed to corporate bonds) if one is especially vulnerable to credit risk.
grok87 wrote:
Sat Oct 07, 2017 3:18 pm
The size of tips markets is $1.7 Trillion ... At $4 Trillion in assets Vanguard is, IMHO, increasingly being forced in both its investing actions and its general investing guidance toward the broadest possible of world assets ... if they told everyone that they should have 10% in TIPs, that is potentially $400 Billion or 25% of the TIPS market. That would have an incredibly distorting effect on the TIPS market. Consequently, Vanguard is NOT going to make that recommendation.
Excellent point, grok! I'd never considered that Vanguard's advice might be colored by such a concern. By the way, the TIPS market is even smaller than you say. According to the Public Debt Statement 9/30/2017 the inflation-indexed principal outstanding is $1,286 billion. (The market value outstanding is about $1,346 billion as shown in cell K49 on the Weight sheet of my 9/30/2017 YTM / Duration calculator.)
whodidntante wrote:
Sat Oct 07, 2017 8:05 pm
If I-bonds are returning 1.96% and we have inflation why are TIPS losing money?
The current I Bond 1.96% annual composite rate reflects the current semi-annual inflation rate of 0.98% from September 2016 to March 2017. Because of the indexation lag, TIPS inflation-indexed principal reflected this same change from 12/1/2016 to 6/1/2017. It so happens that over this period TIPS did not lose money. For example, according to Morningstar Vanguard's VIPSX TIPS fund returned 1.7%. And the on-the-run 0.125% 10-year TIPS maturing July 2026 returned about 2.2%:

Code: Select all

            12/01/16   06/01/17    Change
            --------   --------    ------
Ref CPI      241.428    243.801    +0.98%
Ask price    97.0625   98.21875    +1.19% [*]
Coupon                  0.0625     +0.06%
                                   ------
Total                              +2.23%
Most of the return for this TIPS was due to the price increase. This is because its yield fell from 0.437% on 12/1/2016 to 0.323% on 6/1/2017. [*] If it had risen the same amount, the total return of this TIPS could easily have been negative. Unlike an I Bond which has no interest rate sensitivity, over short periods the inflation component of a TIPS return can easily be swamped by the effect of changes in its real yield.

* Prices and yields are from WSJ TIPS Quotes 12/01/2016 and 06/01/2017.

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Re: Vanguard's long-term outlook for TIPS

Post by Carl53 » Sun Oct 08, 2017 8:19 am

Our two forays into TIPS, outside of a shortlived position in the Vanguard Tips fund, led me to come to the conclusion that TIPs were not for us. Both times interest rates dropped substantially, we sold and profited nicely. The amount of profit, and the fact that despite several years having elapsed neither TIPS to my knowledge has recovered anywhere close to what we sold them for make me nervous as to owning them. While we came out well ahead, it certainly seems that the reverse could have occurred (and did to whoever purchased ours). While the initial purchase was not made with any intent to do other than hold until maturity, the volatility made me think otherwise.

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Re: Vanguard's long-term outlook for TIPS

Post by siamond » Sun Oct 08, 2017 9:55 am

grok87 wrote:
Sat Oct 07, 2017 3:18 pm
1) TIPS Market size:
The size of tips markets is $1.7 Trillion =about 1/20th of the Aggregate Bond Market (i.e. Vanguard Bond Market index which does not include TIPs). See here for a reference- page 7. https://www.nuveen.com/Home/Documents/D ... leId=56370

At $4 Trillion in assets Vanguard is, IMHO, increasingly being forced in both its investing actions and its general investing guidance toward the broadest possible of world assets: Total Stock Index, Total International Stock index, Total Bond index, Total International Bond index etc.

For example if they told everyone that they should have 10% in TIPs, that is potentially $400 Billion or 25% of the TIPS market. That would have an incredibly distorting effect on the TIPS market. Consequently, Vanguard is NOT going to make that recommendation.
That is quite an interesting point you're making. Note that Vanguard operates roughly $1T in bonds, but your point remains. Now one could interpret such line of reasoning as Vanguard being a little biased here, but this isn't how I see it. It seems to me that they are being realistic. The TIPS market apparently suffered from a significant liquidity issue in 2008, which led to a rather eye-popping drop in performance (~12% drawdown) at the worst possible time. Your little math seems to show that the liquidity risk is far from being over. Any deep crisis could end up with the same outcome as 2008 in other words. No, thank you.

PS. in the Nuveen report on page 7, they report the TIPS market size at $1.3T, not $1.7T - as of Aug-2017.

PPS. $1.3T is roughly 10% of the total treasuries market, according the same Nuveen report. If all investors split their bonds 90% treasuries, 10% TIPS (neglecting corporates/etc for a minute), then there should be no liquidity issue. But then there is no meaningful inflation protection either...

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Re: Vanguard's long-term outlook for TIPS

Post by stlutz » Sun Oct 08, 2017 10:20 am

It would be quite unexpected if inflation suddenly shot up to 4% in the next year or two. If that occurred, what do you think would happen with:

a) Nominal bonds?
b) Stocks?
c) TIPS?

The answers are:

a) They would perform poorly.
b) Mostly likely stocks would not like this
c) TIPS would do just fine.

Over the past 10 years nominal bonds have been a much better diversifier of stock market risk than TIPS have been. It's wrong to assume that this must necessarily be the case however. Events just worked out that way. Future events will almost certainly be different--in ways that we don't expect right now.
With respect to my portfolio and beyond, I view my role as being a risk manager, not a return maximizer.
I like your way of putting this, PJW!

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Re: Vanguard's long-term outlook for TIPS

Post by nedsaid » Sun Oct 08, 2017 10:26 am

grok87 wrote:
Sat Oct 07, 2017 3:18 pm
simplesauce wrote:
Sat Oct 07, 2017 12:34 pm
I have half of my bond holdings in TIPS (as suggested by David Swensen.) However, I have read many articles questioning the usefulness and capabilities of TIPS. And I have been concerned about having such a large stake in my portfolio.

Furthermore, Vanguard just sent out an email that concludes:

"While a combination of materially stronger global growth and accommodative monetary policies could drive up inflation over the medium term, that's not the most likely outcome in our view. We expect long-term structural forces (including technology) will result in the United States and many other economies struggling at times to achieve sustainable inflation rates of 2% or more."

Thoughts on the long-term case for TIPS?
A few thoughts on Vanguard's view of TIPS:

1) TIPS Market size:
The size of tips markets is $1.7 Trillion =about 1/20th of the Aggregate Bond Market (i.e. Vanguard Bond Market index which does not include TIPs). See here for a reference- page 7. https://www.nuveen.com/Home/Documents/D ... leId=56370

Nedsaid: Hopefully, that is enough liquidity for the TIPS market. During the 2008-2009 financial crisis, TIPS fell about 10-11% or so, and that was a big surprise to me. They rebounded nicely but didn't provide the diversification benefit that nominal Treasuries provided. I own TIPs myself and have been buying more recently as I have been rebalancing.

At $4 Trillion in assets Vanguard is, IMHO, increasingly being forced in both its investing actions and its general investing guidance toward the broadest possible of world assets: Total Stock Index, Total International Stock index, Total Bond index, Total International Bond index etc.

For example if they told everyone that they should have 10% in TIPs, that is potentially $400 Billion or 25% of the TIPS market. That would have an incredibly distorting effect on the TIPS market. Consequently, Vanguard is NOT going to make that recommendation.

Nedsaid: Great point. Hadn't really thought of that but you are 100% correct. Vanguard is in the uncomfortable position of being so large that a change in their recommendations could move the markets! Something to keep in mind with Vanguard Advisory Service, you won't get particularly specialized advice from them for that reason. No factor tilts with them. Their advice will from here on out be pretty bland.

2) Vanguard may be right that inflation may struggle to get to 2%. But luckily that is how tips are currently priced. 10 year break-even inflation is 1.88% and 30 year breakeven inflation is 1.94%. So one is not paying any or much of an insurance premium to protect against the possibility of a return to a high inflation era like the 1970s.

Nedsaid: Inflation is tame with a couple of exceptions. In certain areas of the country, housing is zooming. Health insurance is also going up more than inflation.

3) Vanguard's Technology argument seems weak and tendentious. Technology is always disruptive but its hard to say if it is any more disruptive now than it was in say the 50s/60s/70s. Before the high inflation of the 70s, inflation was quite low in the 50s and 60s. My crystal ball is cloudy. Low inflation now doesn't mean high inflation can't spring up unexpectedly like it did in the 70s (there is an argument that it may have been related to the vietnam war spending).

Nedsaid: An awful lot of money was created to respond to the 2008-2009 financial crisis, low inflation because a lot of that money has been sitting around doing nothing. The Fed is starting to slowly pare back its balance sheet. There is still slack in the economy and commodity prices, particularly energy, are low. Don't see a resurgence of inflation on the horizon but that doesn't mean it couldn't happen.

cheers,
grok
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Re: Vanguard's long-term outlook for TIPS

Post by Doc » Sun Oct 08, 2017 10:28 am

stlutz wrote:
Sun Oct 08, 2017 10:20 am
Future events will almost certainly be different ...
Just how certain are you that "events will almost certainly be different"? :D

I on the other hand am very certain that I don't know.
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Re: Vanguard's long-term outlook for TIPS

Post by Phineas J. Whoopee » Sun Oct 08, 2017 1:27 pm

#Cruncher wrote:
Sun Oct 08, 2017 7:41 am
baw703916 wrote:
Sat Oct 07, 2017 3:11 pm
TIPS are less risky than nominal Treasuries of the same duration: specifically, they avoid inflation risk.
This is key. If one believes in "taking the risk on the equity side", then TIPS are the logical choice for the bond side of one's portfolio. 100% would be appropriate. I've never understood the argument often made on this forum that one should only own TIPS if they are "necessary"; i.e., if one is especially vulnerable to inflation risk. You never hear it argued that one should only invest in nominal Treasuries (as opposed to corporate bonds) if one is especially vulnerable to credit risk.
...
Because I'm one of the people who make a similar, but subtly different, point, I'd like to respond, and to thank you for prompting a change in how I word my suggestion.

I never, I think, have said one shouldn't own TIPS if one's exposure to inflation is low, but I see now how I may be giving that impression.

I think I'll change to something like:

TIPS are always appropriate in a bond allocation. There is a strong argument for including them if one is especially exposed to the risk of unexpected inflation. It's less strong if one isn't, but that's not to say one shouldn't hold any. All of one's US Treasury bond allocation might well be TIPS. If one chooses 100% Treasuries, a reasonable way to do it is with 100% TIPS.

Does anyone have any suggestions for improvement before I change the way I word my point?

PJW

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Re: Vanguard's long-term outlook for TIPS

Post by dbr » Sun Oct 08, 2017 1:33 pm

Phineas J. Whoopee wrote:
Sun Oct 08, 2017 1:27 pm
#Cruncher wrote:
Sun Oct 08, 2017 7:41 am
baw703916 wrote:
Sat Oct 07, 2017 3:11 pm
TIPS are less risky than nominal Treasuries of the same duration: specifically, they avoid inflation risk.
This is key. If one believes in "taking the risk on the equity side", then TIPS are the logical choice for the bond side of one's portfolio. 100% would be appropriate. I've never understood the argument often made on this forum that one should only own TIPS if they are "necessary"; i.e., if one is especially vulnerable to inflation risk. You never hear it argued that one should only invest in nominal Treasuries (as opposed to corporate bonds) if one is especially vulnerable to credit risk.
...
Because I'm one of the people who make a similar, but subtly different, point, I'd like to respond, and to thank you for prompting a change in how I word my suggestion.

I never, I think, have said one shouldn't own TIPS if one's exposure to inflation is low, but I see now how I may be giving that impression.

I think I'll change to something like:

TIPS are always appropriate in a bond allocation. There is a strong argument for including them if one is especially exposed to the risk of unexpected inflation. It's less strong if one isn't, but that's not to say one shouldn't hold any. All of one's US Treasury bond allocation might well be TIPS. If one chooses 100% Treasuries, a reasonable way to do it is with 100% TIPS.

Any suggestions for improvement before I change the way I word my point?

PJW
I am sympathetic to #Cruncher's observation and like your wording above. I don't think it is a mistake to avoid TIPS, but the case from the point of view of portfolio as a whole and take your risk in equities seems to me to have a rational analysis behind it. The opposite views seem to motivated by people wanting to select bonds as an asset class in isolation. Therefore the concerns of those people would be valid for someone holding nothing but bonds or predominately bonds but should not be concerns for people holding balanced portfolios of stocks and bonds. For the latter the indicated bond holding would be TIPS. There is always the "black swan" view that one should not have too much of one's wealth in a single very much undiversified asset even if it is a US Treasury.

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Re: Vanguard's long-term outlook for TIPS

Post by Mel Lindauer » Sun Oct 08, 2017 1:56 pm

Those "stodgy" old I Bonds with REAL rates of 3.0, 3.3, 3.4 and 3.6% are looking mighty good compared to TIPS right now. Because I backed up the truck over the years (and recommended that others do the same), they provide all the inflation protection I need, so I no longer have any reason to own TIPS.
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Re: Vanguard's long-term outlook for TIPS

Post by Doc » Sun Oct 08, 2017 4:10 pm

A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

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Re: Vanguard's long-term outlook for TIPS

Post by triceratop » Sun Oct 08, 2017 4:48 pm

in_reality wrote:
Sun Oct 08, 2017 7:19 am
triceratop wrote:
Sat Oct 07, 2017 7:57 pm
rrppve wrote:
Sat Oct 07, 2017 3:12 pm
TIPS make a ton of sense, especially for those in or near retirement. Inflation is a real risk that TIPS provide real immunization against.
Don't know why anybody would bother following Vanguard's fixed income advice. Weren't they recommending an allocation to International Bonds when it was clear that at current prices and yields domestic bonds were a far better investment. Their diversification argument never made any sense to me on that point. I'd much rather own TIPS than international bonds.
On what do you base the superior expected returns of owning hedged international bonds? Is it just the yield in issued currency?
I think rrppve is saying that current yields make domestic bonds clearly better.

Actually, Vanguard is saying that the expected return is exactly the same. That an investor should be indifferent because there is a hedge return component which makes them the same.

The diversification benefit then is 1) less trouble if the US defaults [which might be temporarily possible in a budget fight] and more importantly 2) more safety from interest rates hikes because it's unlikely to happen everywhere simultaneously meaning you'll have bonds that haven't suffered NAV loss even if it happens someplace.

The hedge return is real and you will definitely earn it. The question I have is that since it's based on short term rate differentials, how do you earn a term premium. I mean what if the US had a persistently higher sloping yield curve. In such a scenario the international bonds would underperform as the short term hedge return wouldn't cover the bigger rate difference down the yield curve.

Maybe there is an economic reason why the US couldn't maintain a higher sloping yield curve though. (and remember we are talking mostly developed countries in the Vanguard fund- obviously faster growing emerging markets likely will see periods of higher inflations and steeper curves).
Sorry, yes, that's what I meant. And stated completely in reverse!

I agree with you about the problem of short term vs long term and haven't seen a satisfactory answer to this yet. But my point was that, as you stated, the hedge return is real and you should not expect to earn solely the coupon rate.
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Re: Vanguard's long-term outlook for TIPS

Post by Prokofiev » Sun Oct 08, 2017 6:19 pm

Mel Lindauer wrote:
Sun Oct 08, 2017 1:56 pm
Those "stodgy" old I Bonds with REAL rates of 3.0, 3.3, 3.4 and 3.6% are looking mighty good compared to TIPS right now. Because I backed up the truck over the years (and recommended that others do the same), they provide all the inflation protection I need, so I no longer have any reason to own TIPS.
Of course you are comparing I-bonds from the past with TIPS from today. Not fair. Those 3.5-4% , 30-yr TIPS from that time period would being doing very well today.
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Re: Vanguard's long-term outlook for TIPS

Post by Artsdoctor » Sun Oct 08, 2017 6:24 pm

Mel Lindauer wrote:
Sun Oct 08, 2017 1:56 pm
Those "stodgy" old I Bonds with REAL rates of 3.0, 3.3, 3.4 and 3.6% are looking mighty good compared to TIPS right now. Because I backed up the truck over the years (and recommended that others do the same), they provide all the inflation protection I need, so I no longer have any reason to own TIPS.
Wait a minute. Of all people, I can't believe you'd try to compare I-bond rates from years ago with today's TIPs rates. Am I reading your post correctly?

The current fixed rate of I-bonds is 0%. The current variable rate is 1.96%. This hardly anything to write home about.

We all (hopefully) backed up the truck years ago to get both I-bond rates and TIPS rates which were ridiculously high. Those days are gone and you really shouldn't be comparing two rates separated by many years.

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Re: Vanguard's long-term outlook for TIPS

Post by Mel Lindauer » Sun Oct 08, 2017 6:30 pm

Prokofiev wrote:
Sun Oct 08, 2017 6:19 pm
Mel Lindauer wrote:
Sun Oct 08, 2017 1:56 pm
Those "stodgy" old I Bonds with REAL rates of 3.0, 3.3, 3.4 and 3.6% are looking mighty good compared to TIPS right now. Because I backed up the truck over the years (and recommended that others do the same), they provide all the inflation protection I need, so I no longer have any reason to own TIPS.
Of course you are comparing I-bonds from the past with TIPS from today. Not fair. Those 3.5-4% , 30-yr TIPS from that time period would being doing very well today.
Fair enough. However, my point was that back then, some folks considered Savings Bonds to be "stodgy" and for "old folks", but they're looking pretty good right now.

One benefit of Savings Bonds vs those 30-year TIPS you mentioned is that Savings Bonds can never lose value and can be redeemed any time after one year for a guaranteed increase in value, whereas the same can't be said for TIPS. Since TIPS' value is set by the market, they can lose value unless held to maturity.
Best Regards - Mel | | Semper Fi

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Re: Vanguard's long-term outlook for TIPS

Post by Prokofiev » Sun Oct 08, 2017 6:35 pm

At 1% real or less, TIPS are a terrible way to GET rich. But an excellent way to STAY rich.

If I was a young investor today, I would not think of owning TIPS in my portfolio. I would be 90% equities.

But having taken advantage of the bull market of 1981-2000 (I averaged 15% real), I can easily get by with a TIPS ladder over the next 25 years, even at the present .6% real for my overall portfolio. No one should be worried about liquidity or volatility. If the US government cannot pay the coupons or principal on TIPS we will have far greater problems in the market and economy. TIPS are the safest investment I can imagine to preserve capital and stabilize a retirees long-term spending.

Of course the irony of this, is that if you are wealthy enough to get by on .5 or .6% real for the rest of your life, you are probably wealthy enough to be 100% equities without fear of running out of money, even with 50% bear markets. But I find as I get older, the idea of a safe, yearly, inflation protected income stream is more and more appealing.
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Re: Vanguard's long-term outlook for TIPS

Post by Mel Lindauer » Sun Oct 08, 2017 6:51 pm

Prokofiev wrote:
Sun Oct 08, 2017 6:35 pm
At 1% real or less, TIPS are a terrible way to GET rich. But an excellent way to STAY rich.

If I was a young investor today, I would not think of owning TIPS in my portfolio. I would be 90% equities.

But having taken advantage of the bull market of 1981-2000 (I averaged 15% real), I can easily get by with a TIPS ladder over the next 25 years, even at the present .6% real for my overall portfolio. No one should be worried about liquidity or volatility. If the US government cannot pay the coupons or principal on TIPS we will have far greater problems in the market and economy. TIPS are the safest investment I can imagine to preserve capital and stabilize a retirees long-term spending.

Of course the irony of this, is that if you are wealthy enough to get by on .5 or .6% real for the rest of your life, you are probably wealthy enough to be 100% equities without fear of running out of money, even with 50% bear markets. But I find as I get older, the idea of a safe, yearly, inflation protected income stream is more and more appealing.
Agree that once you have "enough", you have options to either invest some portion aggressively for the next generation (your heirs) or simply conserve it's future spending power for your own peace of mind and ability to sleep well at night.
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Re: Vanguard's long-term outlook for TIPS

Post by FIREchief » Sun Oct 08, 2017 8:07 pm

Prokofiev wrote:
Sun Oct 08, 2017 6:35 pm
At 1% real or less, TIPS are a terrible way to GET rich. But an excellent way to STAY rich.
Hear, hear!
If I was a young investor today, I would not think of owning TIPS in my portfolio. I would be 90% equities.

No one should be worried about liquidity or volatility. If the US government cannot pay the coupons or principal on TIPS we will have far greater problems in the market and economy. TIPS are the safest investment I can imagine to preserve capital and stabilize a retirees long-term spending.
+1
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Re: Vanguard's long-term outlook for TIPS

Post by rnitz » Sun Oct 08, 2017 8:18 pm

Prokofiev wrote:
Sun Oct 08, 2017 6:35 pm
... TIPS are a terrible way to GET rich. But an excellent way to STAY rich.
Forgive me for truncating, but what a fantastic, pithy summary. I hope you don't mind me stealing it (with proper respect to your compositions).

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Re: Vanguard's long-term outlook for TIPS

Post by garlandwhizzer » Mon Oct 09, 2017 1:31 pm

The case can be made that the optimal time to buy inflation protection is not when inflation is actively increasing or expected to increase substantially in the near future. At such times, nominal bonds suffer substantial principal loss and TIPS become quite expensive. Currently, little if any inflation is priced into TIPS and it may be a good time to pick up some protection for unexpected inflation with a modest portion of the bond portfolio.

Garland Whizzer

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Re: Vanguard's long-term outlook for TIPS

Post by grok87 » Mon Oct 09, 2017 2:29 pm

#Cruncher wrote:
Sun Oct 08, 2017 7:41 am
grok87 wrote:
Sat Oct 07, 2017 3:18 pm
The size of tips markets is $1.7 Trillion ... At $4 Trillion in assets Vanguard is, IMHO, increasingly being forced in both its investing actions and its general investing guidance toward the broadest possible of world assets ... if they told everyone that they should have 10% in TIPs, that is potentially $400 Billion or 25% of the TIPS market. That would have an incredibly distorting effect on the TIPS market. Consequently, Vanguard is NOT going to make that recommendation.
Excellent point, grok! I'd never considered that Vanguard's advice might be colored by such a concern. By the way, the TIPS market is even smaller than you say. According to the Public Debt Statement 9/30/2017 the inflation-indexed principal outstanding is $1,286 billion. (The market value outstanding is about $1,346 billion as shown in cell K49 on the Weight sheet of my 9/30/2017 YTM / Duration calculator.)
thanks for the correction.

one wonders if someday the US treasury will ramp up tips issuance.
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

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Re: Vanguard's long-term outlook for TIPS

Post by grok87 » Mon Oct 09, 2017 2:31 pm

siamond wrote:
Sun Oct 08, 2017 9:55 am
grok87 wrote:
Sat Oct 07, 2017 3:18 pm
1) TIPS Market size:
The size of tips markets is $1.7 Trillion =about 1/20th of the Aggregate Bond Market (i.e. Vanguard Bond Market index which does not include TIPs). See here for a reference- page 7. https://www.nuveen.com/Home/Documents/D ... leId=56370

At $4 Trillion in assets Vanguard is, IMHO, increasingly being forced in both its investing actions and its general investing guidance toward the broadest possible of world assets: Total Stock Index, Total International Stock index, Total Bond index, Total International Bond index etc.

For example if they told everyone that they should have 10% in TIPs, that is potentially $400 Billion or 25% of the TIPS market. That would have an incredibly distorting effect on the TIPS market. Consequently, Vanguard is NOT going to make that recommendation.
That is quite an interesting point you're making. Note that Vanguard operates roughly $1T in bonds, but your point remains. Now one could interpret such line of reasoning as Vanguard being a little biased here, but this isn't how I see it. It seems to me that they are being realistic. The TIPS market apparently suffered from a significant liquidity issue in 2008, which led to a rather eye-popping drop in performance (~12% drawdown) at the worst possible time. Your little math seems to show that the liquidity risk is far from being over. Any deep crisis could end up with the same outcome as 2008 in other words. No, thank you.

PS. in the Nuveen report on page 7, they report the TIPS market size at $1.3T, not $1.7T - as of Aug-2017.

PPS. $1.3T is roughly 10% of the total treasuries market, according the same Nuveen report. If all investors split their bonds 90% treasuries, 10% TIPS (neglecting corporates/etc for a minute), then there should be no liquidity issue. But then there is no meaningful inflation protection either...
thanks for the correction. the 10% is an interesting figure. i wonder if that was the figure they started out with and planned to perhaps increase the percentage subsequently if demand increased.
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

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Re: Vanguard's long-term outlook for TIPS

Post by grok87 » Mon Oct 09, 2017 2:40 pm

nedsaid wrote:
Sun Oct 08, 2017 10:26 am
A few thoughts on Vanguard's view of TIPS:

1) TIPS Market size:
The size of tips markets is $1.7 Trillion =about 1/20th of the Aggregate Bond Market (i.e. Vanguard Bond Market index which does not include TIPs). See here for a reference- page 7. https://www.nuveen.com/Home/Documents/D ... leId=56370

Nedsaid: Hopefully, that is enough liquidity for the TIPS market. During the 2008-2009 financial crisis, TIPS fell about 10-11% or so, and that was a big surprise to me. They rebounded nicely but didn't provide the diversification benefit that nominal Treasuries provided. I own TIPs myself and have been buying more recently as I have been rebalancing.
[/quote]
Here's how David Swensen approaches the "bonds as diversifiers" in his two books

1) Pioneering Portfolio Management: For institutional investors, written first in 2000.
Recommends long term treasuries as a diversifier

2) Unconventional Success: for individual investors, written second in 2005.
recommends 50/50 mix of treasuries and tips.
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

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