Where's the Inflation Hedge for Short-Term TIPS?

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PriceOfFreedom
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Where's the Inflation Hedge for Short-Term TIPS?

Post by PriceOfFreedom » Sat Aug 25, 2018 11:56 pm

I keep reading that TIPS are an inflation hedge, and that short-term TIPS are less sensitive to interest rate changes and so are closer to a "pure" short-term inflation hedge than longer term TIPS.

Where I am confused is when I examine the return record of Vanguard's Short-Term TIPS Fund (VTAPX). In examining the full years the fund has been in operation, I retrieved the total return from the Vanguard web site, and also computed the CPI increase from the BLS site. Here's what I computed (starting with an arbitraty real value of 100 at the end of 2012:

VTAPX Tot Return CPI Real Return Real Value
2013 -1.54% 1.50% -3.00% 97.00
2014 -1.18% 0.76% -1.92% 95.14
2015 -0.17% 0.73% -0.89% 94.29
2016 2.72% 2.07% +0.63% 94.89
2017 0.82% 2.11% -1.26% 93.69

So for the five full years of operation, VTAPX appears to have lost 6.31% of its real value.

Where's the inflation hedge?

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by tfb » Sun Aug 26, 2018 12:18 am

PriceOfFreedom wrote:
Sat Aug 25, 2018 11:56 pm
So for the five full years of operation, VTAPX appears to have lost 6.31% of its real value.

Where's the inflation hedge?
An inflation hedge doesn't mean a positive real return. Less interest risk rate also doesn't mean no interest rate risk. The real yield on 5-year TIPS was negative 1.5% at the beginning of 2013. It rose to 0% at the end of 2013, and to 0.4% at the end of 2014. Higher yield brought lower prices. The real yield on 5-year TIPS also rose in 2017.

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by #Cruncher » Sun Aug 26, 2018 9:50 am

tfb wrote:
Sun Aug 26, 2018 12:18 am
An inflation hedge doesn't mean a positive real return.
Precisely! The real yield of 5-year TIPS started out at -1.36% Jan 1, 2013; so it's not surprising the real return over the next five years would be negative. 5-year TIPS yields rose 1.71% points to +0.35% Jan 1, 2018. (See 5-year constant maturity TIPS yields, 2013 and 2018.) But this was a double-edged sword. While new short term TIPS will benefit from the higher yields, they can depress the values of existing issues.

The poor five year return of VTAPX is roughly matched by the -1.311% real return one would have gotten from purchasing the 5-year TIPS maturing 4/15/2018 at the 4/18/2013 auction. Because inflation was less than expected, with 20-20 hindsight, one would have done better to purchase a 5-year nominal Treasury on 4/18/2013. As shown at the bottom of my post, Re: Treasury Notes Return vs Actual TIPS Return, its +0.71% yield to maturity would have beaten by 0.66% points the +0.05% actual yield of the TIPS when adjusted for inflation.

Surprisingly, Vanguard's broad term TIPS fund, VAIPX, performed about same as VTAPX over the five years. This was because medium and long term TIPS yields started out higher in 2013 and didn't rise as much over the next five years as short term TIPS yields. E.g., while 5-year yields rose 1.71% points from -1.36% to +0.35%, 10-year yields rose only 1.08% points from -0.62% to +0.46%.

This is shown below where I added VAIPX to the original poster's table and also used the October CPI (since that determines the annual TIPS inflation adjustment) to convert Vanguard's returns to real returns. VAIPX's -1.22% average annual five year return is almost identical to VTAPX's -1.16%. But the short term fund was much less volatile. While VAIPX's annual change ranged from -9.73% to +2.94%, VTAPX's ranged from only -2.80% to +1.07%.

Code: Select all

                         ---- VTAPX (Short) ----   ---- VAIPX (Broad) ----
        October CPI-U    Vguard    Real    Gros    Vguard    Real    Grows
Year    Value   Change   Change   Change    To     Change   Change    To
----   -------  ------   ------   ------  ------   ------   ------  ------
2012   231.317                            100.00                    100.00
2013   233.546   0.96%   (1.54%)  (2.48%)  97.52   (8.86%)  (9.73%)  90.27
2014   237.433   1.66%   (1.18%)  (2.80%)  94.79    3.97%    2.27%   92.32
2015   237.838   0.17%   (0.17%)  (0.34%)  94.47   (1.69%)  (1.86%)  90.60
2016   241.729   1.64%    2.72%    1.07%   95.48    4.62%    2.94%   93.26
2017   246.663   2.04%    0.82%   (1.20%)  94.33    2.91%    0.85%   94.06
                 -----             -----                     -----
5 Yr Average     1.29%            (1.16%)                   (1.22%)

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by whodidntante » Sun Aug 26, 2018 9:55 am

I Bonds might be closer to what you are looking for because they are not marked to market. However, there is no perfect instrument to protect you from inflation. The CPI is a generalized model for inflation, but it's not representative for your situation and your costs. So I don't think it's a gigantic concern whether your "inflation protected" investments track it or not.

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by willthrill81 » Sun Aug 26, 2018 10:05 am

Many believe that TIPS are a 'free lunch' when it comes to protecting against inflation. They are not. You pay a price for the 'insurance' that they provide.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by FIREchief » Sun Aug 26, 2018 10:46 am

willthrill81 wrote:
Sun Aug 26, 2018 10:05 am
Many believe that TIPS are a 'free lunch' when it comes to protecting against inflation. They are not. You pay a price for the 'insurance' that they provide.
I think a broad brush statement like that requires a bit more explanation for the casual reader. While it is impossible to precisely establish the premium paid for insurance protection, there is a strong argument to be made that it is close to zero based upon the current breakeven inflation rates on treasuries as compared to Fed targets and analyst projections.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by Rager1 » Sun Aug 26, 2018 11:20 am

Don't forget that TIPS are designed to protect you from "unexpected" inflation. That hasn't happened yet.

Ed

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by FIREchief » Sun Aug 26, 2018 11:32 am

Rager1 wrote:
Sun Aug 26, 2018 11:20 am
Don't forget that TIPS are designed to protect you from "unexpected" inflation. That hasn't happened yet.

Ed
If we accept that the breakeven inflation rate reflects "expected inflation," then yes it has. Inflation has been 2.95% over the past twelve months (latest reported CPI-U July 2018 versus July 2017). The breakeven inflation rate for five year TIPS twelve months ago was 1.62% (using July 14 treasury yield curves). The person who bought the five year TIPS has benefited from a 1.33% unexpected inflation adjustment. I would say that is pretty good protection that has actually happened just now. :sharebeer
Last edited by FIREchief on Fri Sep 07, 2018 12:53 pm, edited 2 times in total.
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PriceOfFreedom
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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by PriceOfFreedom » Sun Aug 26, 2018 11:56 am

OP here. Thank you for all your replies and insights. #Cruncher, your analysis is very cogent, as usual.

So with the 5 year TIPS real yield currently at +0.73%, is it reasonable to assume that the real yield of VTAPX over the next five years would be approximately that, assuming that real 5-year rates remain the same (big assumption)?

In fact, would it be generally correct to assume the real total yield of VTAPX over the next five years would be approximately:

(1+0.73%+0.5*(0.73%-real 5-year TIPS yield in 2023))^5

(less its expense ratio and other trading costs, and assuming a linear change in real yields for the next five years).

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by garlandwhizzer » Sun Aug 26, 2018 1:53 pm

PriceOfFreedom wrote:

In fact, would it be generally correct to assume the real total yield of VTAPX over the next five years would be approximately:
It would not be correct to accurately predict what the real total yield of VTAPX will be over the next 5 years or for that matter any other bond fund's total real yield. The real yield of VTAPX will vary as will its bond portfolio yield and the principal value of each share due to dynamic market forces that are not predicable beforehand. If investors get worried about long term increasing inflation, the search for inflation protection will increase purchases of inflation hedges like VTAPX. That in turn will push its share principal value higher and therefore its real yield lower until it comes into equilibrium with the expected real yield nominal bonds (nominal yield minus that increasing expected inflation) of similar duration and risk. Currently few expect long term increasing inflation which is why the real yields of VTAPX are IMO attractive now relative to other bonds of similar safety profile. Our gradually increasing inflation has not yet rung investors alarm bells, one reason why VTAPX with an 0.85% real yield (add 2+% to that for comparison with nominals at present) has outperformed all other Vanguard bond funds YTD and over the last year.

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by permport » Sun Aug 26, 2018 2:03 pm

Just my opinion, but I personally think TIPS can be foregone entirely. Besides the fact that official inflation calculations consistently understate real inflation, the idea of buying fire insurance from a maniac arsonist just seems silly.
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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by jeffyscott » Sun Aug 26, 2018 3:09 pm

PriceOfFreedom wrote:
Sun Aug 26, 2018 11:56 am
So with the 5 year TIPS real yield currently at +0.73%, is it reasonable to assume that the real yield of VTAPX over the next five years would be approximately that, assuming that real 5-year rates remain the same (big assumption)?
No, because the average maturity of VTAPX is only 2.8 years.

Or yes, because the current SEC (real) yield is 0.85%, so it is similar to the 5 year TIPS yield.

:?: :confused
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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by willthrill81 » Sun Aug 26, 2018 3:14 pm

FIREchief wrote:
Sun Aug 26, 2018 10:46 am
willthrill81 wrote:
Sun Aug 26, 2018 10:05 am
Many believe that TIPS are a 'free lunch' when it comes to protecting against inflation. They are not. You pay a price for the 'insurance' that they provide.
I think a broad brush statement like that requires a bit more explanation for the casual reader. While it is impossible to precisely establish the premium paid for insurance protection, there is a strong argument to be made that it is close to zero based upon the current breakeven inflation rates on treasuries as compared to Fed targets and analyst projections.
The premium for TIPS is indeed low right now, but it's not zero. As noted by others, TIPS are designed to protect against 'unexpected' inflation.
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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by aristotelian » Sun Aug 26, 2018 3:23 pm

willthrill81 wrote:
Sun Aug 26, 2018 10:05 am
Many believe that TIPS are a 'free lunch' when it comes to protecting against inflation. They are not. You pay a price for the 'insurance' that they provide.
Can you explain? Intuitively they should only return negative with negative inflation. Like OP I have followed TIPS funds and do not understand the negative returns even with positive inflation. Other than the risk of negative inflation, what is the "price" you pay for TIPS?

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by willthrill81 » Sun Aug 26, 2018 3:28 pm

aristotelian wrote:
Sun Aug 26, 2018 3:23 pm
willthrill81 wrote:
Sun Aug 26, 2018 10:05 am
Many believe that TIPS are a 'free lunch' when it comes to protecting against inflation. They are not. You pay a price for the 'insurance' that they provide.
Can you explain? Intuitively they should only return negative with negative inflation. Like OP I have followed TIPS funds and do not understand the negative returns even with positive inflation. Other than the risk of negative inflation, what is the "price" you pay for TIPS?
If actual inflation matches up with the market's expected inflation, then nominal bonds of the same duration as TIPS will outperform the TIPS. It is only if actual inflation is greater than the market's originally expected inflation that TIPS will come out ahead of nominal bonds of the same duration.

FIREchief's statement, which I agree with, is that in the current environment, the premium being paid for TIPS' 'insurance' against unexpected inflation is currently low. But it's not zero.

Let's compare VTAPX, Vanguard's short-term TIPS fund, to their short-term Treasuries fund, VFIRX, which currently has the same average effective maturity. Since Jan., 2013, VTAPX has had a real CAGR of -1.46% vs. VFIRX's -1.16%. That .30% lower return for VTAPX was the 'premium' paid for the TIPS' 'insurance'.

Vanguard's description of VTPAX directly addresses the use of TIPS.
The fund’s income can fluctuate in response to both changes in interest rates and changes in the rate of inflation. The fund can play a valuable role in already diversified fixed income portfolio by helping to protect investors from inflationary surprises or ”unexpected inflation.”
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by FIREchief » Sun Aug 26, 2018 3:40 pm

willthrill81 wrote:
Sun Aug 26, 2018 3:28 pm
aristotelian wrote:
Sun Aug 26, 2018 3:23 pm
willthrill81 wrote:
Sun Aug 26, 2018 10:05 am
Many believe that TIPS are a 'free lunch' when it comes to protecting against inflation. They are not. You pay a price for the 'insurance' that they provide.
Can you explain? Intuitively they should only return negative with negative inflation. Like OP I have followed TIPS funds and do not understand the negative returns even with positive inflation. Other than the risk of negative inflation, what is the "price" you pay for TIPS?
If actual inflation matches up with the market's expected inflation, then nominal bonds of the same duration as TIPS will outperform the TIPS. It is only if actual inflation is greater than the market's originally expected inflation that TIPS will come out ahead of nominal bonds of the same duration.

FIREchief's statement, which I agree with, is that in the current environment, the premium being paid for TIPS' 'insurance' against unexpected inflation is currently very low. But it's not zero.
While your argument is consistent with that of some of the "experts," I will challenge you or any of them to tell me what the current price is. The breakeven inflation rate for 10 year treasuries is currently 2.09%. Since the Fed's long term target is supposedly 2.00%, I guess we could believe that they will 100% hit their target and assume an inflation protection premium for TIPS of 0.09%. I don't think that's unreasonable, but 9 basis points is very cheap insurance against unexpected inflation over the next ten years. Perhaps not a "free lunch," but we're talking Ramen lunch prices here, not Steak and Martinis. As I posted a few posts back, the TIPS insurance that we were buying last July wound up being a great deal (so far). Of course, the Fed's target was 2.0% back then as well, so logic is taking a beating here.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by willthrill81 » Sun Aug 26, 2018 3:43 pm

FIREchief wrote:
Sun Aug 26, 2018 3:40 pm
willthrill81 wrote:
Sun Aug 26, 2018 3:28 pm
aristotelian wrote:
Sun Aug 26, 2018 3:23 pm
willthrill81 wrote:
Sun Aug 26, 2018 10:05 am
Many believe that TIPS are a 'free lunch' when it comes to protecting against inflation. They are not. You pay a price for the 'insurance' that they provide.
Can you explain? Intuitively they should only return negative with negative inflation. Like OP I have followed TIPS funds and do not understand the negative returns even with positive inflation. Other than the risk of negative inflation, what is the "price" you pay for TIPS?
If actual inflation matches up with the market's expected inflation, then nominal bonds of the same duration as TIPS will outperform the TIPS. It is only if actual inflation is greater than the market's originally expected inflation that TIPS will come out ahead of nominal bonds of the same duration.

FIREchief's statement, which I agree with, is that in the current environment, the premium being paid for TIPS' 'insurance' against unexpected inflation is currently very low. But it's not zero.
While your argument is consistent with that of some of the "experts," I will challenge you or any of them to tell me what the current price is. The breakeven inflation rate for 10 year treasuries is currently 2.09%. Since the Fed's long term target is supposedly 2.00%, I guess we could believe that they will 100% hit their target and assume an inflation protection premium for TIPS of 0.09%. I don't think that's unreasonable, but 9 basis points is very cheap insurance against unexpected inflation over the next ten years. Perhaps not a "free lunch," but we're talking Ramen lunch prices here, not Steak and Martinis. As I posted a few posts back, the TIPS insurance that we were buying last July wound up being a great deal (so far). Of course, the Fed's target was 2.0% back then as well, so logic is taking a beating here.
The comparison I subsequently added to my post showed that the TIPS premium from Jan., 2013, until now was 30 basis points. I agree that that's not a hefty price, but it's not zero. In the current low yield environment, 30 basis points is considered to be 'hefty' by some in the fixed income space, especially for short-term bonds.
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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by aristotelian » Sun Aug 26, 2018 3:46 pm

willthrill81 wrote:
Sun Aug 26, 2018 3:28 pm

Vanguard's description of VTPAX directly addresses the use of TIPS.
The fund’s income can fluctuate in response to both changes in interest rates and changes in the rate of inflation. The fund can play a valuable role in already diversified fixed income portfolio by helping to protect investors from inflationary surprises or ”unexpected inflation.”
That explains why VTAPX would underperform a comparable bond fund. Still, I am having trouble grasping negative returns. Does that have to do with inflation expectations changing? If the market expects lower inflation, the price of VTAPX goes down regardless of actual inflation?

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by FIREchief » Sun Aug 26, 2018 3:47 pm

willthrill81 wrote:
Sun Aug 26, 2018 3:43 pm
FIREchief wrote:
Sun Aug 26, 2018 3:40 pm
willthrill81 wrote:
Sun Aug 26, 2018 3:28 pm
aristotelian wrote:
Sun Aug 26, 2018 3:23 pm
willthrill81 wrote:
Sun Aug 26, 2018 10:05 am
Many believe that TIPS are a 'free lunch' when it comes to protecting against inflation. They are not. You pay a price for the 'insurance' that they provide.
Can you explain? Intuitively they should only return negative with negative inflation. Like OP I have followed TIPS funds and do not understand the negative returns even with positive inflation. Other than the risk of negative inflation, what is the "price" you pay for TIPS?
If actual inflation matches up with the market's expected inflation, then nominal bonds of the same duration as TIPS will outperform the TIPS. It is only if actual inflation is greater than the market's originally expected inflation that TIPS will come out ahead of nominal bonds of the same duration.

FIREchief's statement, which I agree with, is that in the current environment, the premium being paid for TIPS' 'insurance' against unexpected inflation is currently very low. But it's not zero.
While your argument is consistent with that of some of the "experts," I will challenge you or any of them to tell me what the current price is. The breakeven inflation rate for 10 year treasuries is currently 2.09%. Since the Fed's long term target is supposedly 2.00%, I guess we could believe that they will 100% hit their target and assume an inflation protection premium for TIPS of 0.09%. I don't think that's unreasonable, but 9 basis points is very cheap insurance against unexpected inflation over the next ten years. Perhaps not a "free lunch," but we're talking Ramen lunch prices here, not Steak and Martinis. As I posted a few posts back, the TIPS insurance that we were buying last July wound up being a great deal (so far). Of course, the Fed's target was 2.0% back then as well, so logic is taking a beating here.
The comparison I subsequently added to my post showed that the TIPS premium from Jan., 2013, until now was 30 basis points. I agree that that's not a hefty price, but it's not zero. In the current low yield environment, 30 basis points is considered to be 'hefty' by some in the fixed income space, especially for short-term bonds.
I don't believe that you can compare a TIPS fund with a nominal treasury fund and generate any meaningful conclusions. One of the reasons is that I don't believe there is an acceptable way to calculate duration for a TIPS fund. I know that the TIPS funds have published numbers, but some of our experts here on the forum have pointed out that they are highly questionable. I don't have a link right now, but maybe one of them will weigh in.
Last edited by FIREchief on Sun Aug 26, 2018 4:55 pm, edited 1 time in total.
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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by willthrill81 » Sun Aug 26, 2018 3:56 pm

aristotelian wrote:
Sun Aug 26, 2018 3:46 pm
willthrill81 wrote:
Sun Aug 26, 2018 3:28 pm

Vanguard's description of VTPAX directly addresses the use of TIPS.
The fund’s income can fluctuate in response to both changes in interest rates and changes in the rate of inflation. The fund can play a valuable role in already diversified fixed income portfolio by helping to protect investors from inflationary surprises or ”unexpected inflation.”
That explains why VTAPX would underperform a comparable bond fund. Still, I am having trouble grasping negative returns. Does that have to do with inflation expectations changing? If the market expects lower inflation, the price of VTAPX goes down regardless of actual inflation?
This article below provides an excellent explanation of why. I've included a particularly relevant excerpt, but the whole thing is definitely worth a read.
How TIPS Can Have Negative Yields

The answer is that the yield on a TIPS bond is equal to the Treasury bond yield minus the rate of expected inflation.This is an essential characteristic of TIPS -- they are designed that way. As a result, when standard Treasury bonds are trading at yields that are below the expected inflation rate – as has been the case since late 2010 – TIPS yields will fall into negative territory.

Let’s look at July 17, 2012, again as an example. On that day, the 10-year Treasury note was yielding 1.49%. However, based on the comparative yields of TIPS versus plain-vanilla Treasuries, investors were expecting inflation of about 2.13% in the next ten years. If you subtract this 2.13% from the 10-year yield of 1.49%, the result is a negative number for the 10-year TIPS: -0.64%. As long as Treasuries continue to offer yields below the rate of expected inflation, TIPS will remain in negative territory.
https://www.thebalance.com/why-are-tips ... ive-416876
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by aristotelian » Sun Aug 26, 2018 4:14 pm

willthrill81 wrote:
Sun Aug 26, 2018 3:56 pm

This article below provides an excellent explanation of why. I've included a particularly relevant excerpt, but the whole thing is definitely worth a read.
How TIPS Can Have Negative Yields

The answer is that the yield on a TIPS bond is equal to the Treasury bond yield minus the rate of expected inflation.This is an essential characteristic of TIPS -- they are designed that way. As a result, when standard Treasury bonds are trading at yields that are below the expected inflation rate – as has been the case since late 2010 – TIPS yields will fall into negative territory.

Let’s look at July 17, 2012, again as an example. On that day, the 10-year Treasury note was yielding 1.49%. However, based on the comparative yields of TIPS versus plain-vanilla Treasuries, investors were expecting inflation of about 2.13% in the next ten years. If you subtract this 2.13% from the 10-year yield of 1.49%, the result is a negative number for the 10-year TIPS: -0.64%. As long as Treasuries continue to offer yields below the rate of expected inflation, TIPS will remain in negative territory.
https://www.thebalance.com/why-are-tips ... ive-416876
I will take a look at that article. However, sorry to be difficult, but I was asking about what might cause negative return, not yield. What would cause negative return of a fund like VTAPX, even when inflation is positive? For example, Vanguard is showing -1.59% and -1.98% capital return in 2013-14, even though inflation was positive.
Last edited by aristotelian on Sun Aug 26, 2018 4:19 pm, edited 1 time in total.

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by willthrill81 » Sun Aug 26, 2018 4:18 pm

aristotelian wrote:
Sun Aug 26, 2018 4:14 pm
willthrill81 wrote:
Sun Aug 26, 2018 3:56 pm

This article below provides an excellent explanation of why. I've included a particularly relevant excerpt, but the whole thing is definitely worth a read.
How TIPS Can Have Negative Yields

The answer is that the yield on a TIPS bond is equal to the Treasury bond yield minus the rate of expected inflation.This is an essential characteristic of TIPS -- they are designed that way. As a result, when standard Treasury bonds are trading at yields that are below the expected inflation rate – as has been the case since late 2010 – TIPS yields will fall into negative territory.

Let’s look at July 17, 2012, again as an example. On that day, the 10-year Treasury note was yielding 1.49%. However, based on the comparative yields of TIPS versus plain-vanilla Treasuries, investors were expecting inflation of about 2.13% in the next ten years. If you subtract this 2.13% from the 10-year yield of 1.49%, the result is a negative number for the 10-year TIPS: -0.64%. As long as Treasuries continue to offer yields below the rate of expected inflation, TIPS will remain in negative territory.
https://www.thebalance.com/why-are-tips ... ive-416876
I will take a look at that article. However, sorry to be difficult, but I was asking about what might cause negative return, not yield. What would cause negative return of a fund like VTAPX?
Negative returns are a result of negative yield. The initial yields on short-term TIPS offered a few years ago were negative, hence the negative returns down the line.

This FED web page demonstrates this. Five year TIPS had negative real yields (very briefly) as recently as June, 2017.
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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by willthrill81 » Sun Aug 26, 2018 4:34 pm

FIREchief wrote:
Sun Aug 26, 2018 3:47 pm
willthrill81 wrote:
Sun Aug 26, 2018 3:43 pm
FIREchief wrote:
Sun Aug 26, 2018 3:40 pm
willthrill81 wrote:
Sun Aug 26, 2018 3:28 pm
aristotelian wrote:
Sun Aug 26, 2018 3:23 pm


Can you explain? Intuitively they should only return negative with negative inflation. Like OP I have followed TIPS funds and do not understand the negative returns even with positive inflation. Other than the risk of negative inflation, what is the "price" you pay for TIPS?
If actual inflation matches up with the market's expected inflation, then nominal bonds of the same duration as TIPS will outperform the TIPS. It is only if actual inflation is greater than the market's originally expected inflation that TIPS will come out ahead of nominal bonds of the same duration.

FIREchief's statement, which I agree with, is that in the current environment, the premium being paid for TIPS' 'insurance' against unexpected inflation is currently very low. But it's not zero.
While your argument is consistent with that of some of the "experts," I will challenge you or any of them to tell me what the current price is. The breakeven inflation rate for 10 year treasuries is currently 2.09%. Since the Fed's long term target is supposedly 2.00%, I guess we could believe that they will 100% hit their target and assume an inflation protection premium for TIPS of 0.09%. I don't think that's unreasonable, but 9 basis points is very cheap insurance against unexpected inflation over the next ten years. Perhaps not a "free lunch," but we're talking Ramen lunch prices here, not Steak and Martinis. As I posted a few posts back, the TIPS insurance that we were buying last July wound up being a great deal (so far). Of course, the Fed's target was 2.0% back then as well, so logic is taking a beating here.
The comparison I subsequently added to my post showed that the TIPS premium from Jan., 2013, until now was 30 basis points. I agree that that's not a hefty price, but it's not zero. In the current low yield environment, 30 basis points is considered to be 'hefty' by some in the fixed income space, especially for short-term bonds.
I don't believe that you can compare a TIPS fund with a nominal treasury fund and generate any meaningful conclusions. One of the reasons is that I don't believe there is an acceptable was to calculate duration for a TIPS fund. I know that the TIPS funds have published numbers, but some of our experts here on the forum have pointed out that they are highly questionable. I don't have a link right now, but maybe one of them will weigh in.
Given that TIPS are just bonds in 'real dollars' instead of nominal dollars like nominal bonds, I'm not sure why you can't do a meaningful comparison. TIPS yield is based in part on Treasury bond yields.
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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by aristotelian » Sun Aug 26, 2018 4:46 pm

willthrill81 wrote:
Sun Aug 26, 2018 4:18 pm

Negative returns are a result of negative yield. The initial yields on short-term TIPS offered a few years ago were negative, hence the negative returns down the line.

This FED web page demonstrates this. Five year TIPS had negative real yields (very briefly) as recently as June, 2017.
Thanks for trying. I still don't get it. VG data says the fund had negative capital appreciation and this was the main source of negative total return in 2013-14. I will just stay away and buy TIPS directly rather than through a fund if I ever decide to go that route. IMO, negative returns during positive inflation does not seem like very good inflation protection!

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by FIREchief » Sun Aug 26, 2018 4:58 pm

aristotelian wrote:
Sun Aug 26, 2018 4:14 pm
willthrill81 wrote:
Sun Aug 26, 2018 3:56 pm

This article below provides an excellent explanation of why. I've included a particularly relevant excerpt, but the whole thing is definitely worth a read.
How TIPS Can Have Negative Yields

The answer is that the yield on a TIPS bond is equal to the Treasury bond yield minus the rate of expected inflation.This is an essential characteristic of TIPS -- they are designed that way. As a result, when standard Treasury bonds are trading at yields that are below the expected inflation rate – as has been the case since late 2010 – TIPS yields will fall into negative territory.

Let’s look at July 17, 2012, again as an example. On that day, the 10-year Treasury note was yielding 1.49%. However, based on the comparative yields of TIPS versus plain-vanilla Treasuries, investors were expecting inflation of about 2.13% in the next ten years. If you subtract this 2.13% from the 10-year yield of 1.49%, the result is a negative number for the 10-year TIPS: -0.64%. As long as Treasuries continue to offer yields below the rate of expected inflation, TIPS will remain in negative territory.
https://www.thebalance.com/why-are-tips ... ive-416876
I will take a look at that article. However, sorry to be difficult, but I was asking about what might cause negative return, not yield. What would cause negative return of a fund like VTAPX, even when inflation is positive? For example, Vanguard is showing -1.59% and -1.98% capital return in 2013-14, even though inflation was positive.
It's because interest rates were rising, which causes the immediate value of all bonds to fall.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by FIREchief » Sun Aug 26, 2018 5:02 pm

willthrill81 wrote:
Sun Aug 26, 2018 4:34 pm
FIREchief wrote:
Sun Aug 26, 2018 3:47 pm
willthrill81 wrote:
Sun Aug 26, 2018 3:43 pm
FIREchief wrote:
Sun Aug 26, 2018 3:40 pm
willthrill81 wrote:
Sun Aug 26, 2018 3:28 pm


If actual inflation matches up with the market's expected inflation, then nominal bonds of the same duration as TIPS will outperform the TIPS. It is only if actual inflation is greater than the market's originally expected inflation that TIPS will come out ahead of nominal bonds of the same duration.

FIREchief's statement, which I agree with, is that in the current environment, the premium being paid for TIPS' 'insurance' against unexpected inflation is currently very low. But it's not zero.
While your argument is consistent with that of some of the "experts," I will challenge you or any of them to tell me what the current price is. The breakeven inflation rate for 10 year treasuries is currently 2.09%. Since the Fed's long term target is supposedly 2.00%, I guess we could believe that they will 100% hit their target and assume an inflation protection premium for TIPS of 0.09%. I don't think that's unreasonable, but 9 basis points is very cheap insurance against unexpected inflation over the next ten years. Perhaps not a "free lunch," but we're talking Ramen lunch prices here, not Steak and Martinis. As I posted a few posts back, the TIPS insurance that we were buying last July wound up being a great deal (so far). Of course, the Fed's target was 2.0% back then as well, so logic is taking a beating here.
The comparison I subsequently added to my post showed that the TIPS premium from Jan., 2013, until now was 30 basis points. I agree that that's not a hefty price, but it's not zero. In the current low yield environment, 30 basis points is considered to be 'hefty' by some in the fixed income space, especially for short-term bonds.
I don't believe that you can compare a TIPS fund with a nominal treasury fund and generate any meaningful conclusions. One of the reasons is that I don't believe there is an acceptable was to calculate duration for a TIPS fund. I know that the TIPS funds have published numbers, but some of our experts here on the forum have pointed out that they are highly questionable. I don't have a link right now, but maybe one of them will weigh in.
Given that TIPS are just bonds in 'real dollars' instead of nominal dollars like nominal bonds, I'm not sure why you can't do a meaningful comparison. TIPS yield is based in part on Treasury bond yields.
With a nominal bond, the exact return is known, so duration can be precisely calculated. This is not true of a TIPS. If you can't calaculate and control duration, you can't make an apples to apples comparison of a TIPS fund and a nominal treauries fund. I'll refer you back to my post on 12 month performance of an individual ten year TIPS versus an individual ten year Treasury Note above. There certainly was not a 30 basis point premium paid for that inflation insurance, and it has paid off very well so far.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by AlphaLess » Sun Aug 26, 2018 5:15 pm

Interest rate risk (curve risk) as well as inflation rate (curve risk) is only real for longer-term maturities.

TIPS are hedge for inflation, but not necessarily the most superior return instrument.

If someone gave me a choice between a 1% 30-year TIP and a 15% coupon, par 30-year bond, I will take the second any day, under current circumstances.

Currently, inflation expectation is pretty much 2.0 -2.5% all the way out to 30 years.

Imagine you have $200K. You invest $100K into the regular 30-year bond (currently paying something like 2.97% coupon), and $100K into the 30 year TIP, currently with 0.86% coupon (plus inflation).

Let's say inflation stays at around 2-2.2% for about 10 years, and then, starting at 2028, all of a sudden jumps to 8% and stays there until 2048.

In that case, the 30-year TIP would be a superior product because your measly 2.97% coupon on the regular 30-year will not be enough to keep up with the 8% inflation.

But outside of the contrived example I have presented, that does not happen.
Firstly, it is irresponsible to buy $100K in a regular 30-year and $100K in a 30-year TIP: too much duration risk.
Most investment advice is to get an average 5-year duration bond fund.

With a fund like that, you have less of an UNEXPECTED inflation risk.
As inflation expectations go higher, that fund will slowly purchase NEW bonds which have the new inflation expectation baked in.

Another think to consider is yield vs risk. Currently, the yield curve is very flat, so you don't get much by going from 5-year to 30-year.
Again, by having a bund fund, you will be covered in this respect.

Another thing to note is that SHORTER term (like 12 months or 18 months or less) fixed income instruments such as treasuries, CDs, corporate bonds, and TIPs will not compensate you for inflation risk. For the past 5-years or so inflation has been chugging along at 2%, but all of the above have been yielding less than that.

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by willthrill81 » Sun Aug 26, 2018 6:02 pm

FIREchief wrote:
Sun Aug 26, 2018 5:02 pm
willthrill81 wrote:
Sun Aug 26, 2018 4:34 pm
FIREchief wrote:
Sun Aug 26, 2018 3:47 pm
willthrill81 wrote:
Sun Aug 26, 2018 3:43 pm
FIREchief wrote:
Sun Aug 26, 2018 3:40 pm


While your argument is consistent with that of some of the "experts," I will challenge you or any of them to tell me what the current price is. The breakeven inflation rate for 10 year treasuries is currently 2.09%. Since the Fed's long term target is supposedly 2.00%, I guess we could believe that they will 100% hit their target and assume an inflation protection premium for TIPS of 0.09%. I don't think that's unreasonable, but 9 basis points is very cheap insurance against unexpected inflation over the next ten years. Perhaps not a "free lunch," but we're talking Ramen lunch prices here, not Steak and Martinis. As I posted a few posts back, the TIPS insurance that we were buying last July wound up being a great deal (so far). Of course, the Fed's target was 2.0% back then as well, so logic is taking a beating here.
The comparison I subsequently added to my post showed that the TIPS premium from Jan., 2013, until now was 30 basis points. I agree that that's not a hefty price, but it's not zero. In the current low yield environment, 30 basis points is considered to be 'hefty' by some in the fixed income space, especially for short-term bonds.
I don't believe that you can compare a TIPS fund with a nominal treasury fund and generate any meaningful conclusions. One of the reasons is that I don't believe there is an acceptable was to calculate duration for a TIPS fund. I know that the TIPS funds have published numbers, but some of our experts here on the forum have pointed out that they are highly questionable. I don't have a link right now, but maybe one of them will weigh in.
Given that TIPS are just bonds in 'real dollars' instead of nominal dollars like nominal bonds, I'm not sure why you can't do a meaningful comparison. TIPS yield is based in part on Treasury bond yields.
With a nominal bond, the exact return is known, so duration can be precisely calculated. This is not true of a TIPS. If you can't calaculate and control duration, you can't make an apples to apples comparison of a TIPS fund and a nominal treauries fund. I'll refer you back to my post on 12 month performance of an individual ten year TIPS versus an individual ten year Treasury Note above. There certainly was not a 30 basis point premium paid for that inflation insurance, and it has paid off very well so far.
With nominal bonds, you know the exact nominal return when you buy them (apart from principal appreciation/depreciation). With TIPS, you know the exact real return upon purchase (apart from principal changes and significant deflation, if the latter occurred).

I do not doubt at all that you experienced a difference between purchasing individual TIPS versus a TIPS fund. That is also true of nominal bonds. But the return of Vanguard's TIPS fund versus their short-term Treasury fund with the exact same average effective maturity is undeniable.
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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by jalbert » Sun Aug 26, 2018 7:06 pm

The original premise that TIPS are purported to be an inflation hedge is not correct. That is too strong of a term. TIPS diversify the risk of inflation being higher than the market expects. They do not eliminate the risk.

In fact, they only attempt to eliminate the risk in themselves. Nominal treasuries have inflation risk and term risk. With TIPS the inflation risk of the bonds goes away but you still have term risk.

TIPS certainly do not hedge any inflation risk in other assets held.
Risk is not a guarantor of return.

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by Phineas J. Whoopee » Sun Aug 26, 2018 7:48 pm

PriceOfFreedom wrote:
Sat Aug 25, 2018 11:56 pm
I keep reading that TIPS are an inflation hedge, and that short-term TIPS are less sensitive to interest rate changes and so are closer to a "pure" short-term inflation hedge than longer term TIPS.
...
You keep reading wrong information.

What is a hedge? Read right information on it.

What is duration risk? Read right information on it.

What is real yield versus nominal yield? Read right information on it.

PJW

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by tfb » Sun Aug 26, 2018 8:06 pm

aristotelian wrote:
Sun Aug 26, 2018 4:46 pm
VG data says the fund had negative capital appreciation and this was the main source of negative total return in 2013-14. I will just stay away and buy TIPS directly rather than through a fund if I ever decide to go that route.
Buying a 5-year TIPS in 2013 would've guaranteed that you had a negative real return when that TIPS matured. It would've also dropped in value in both real and nominal terms during 2013-14. That was the deal accepted in the marketplace. You could've bought I-bonds in limited quantity, but that was it. You could've bought 5-year regular Treasury with the same expected negative real return. The 5-year regular Treasury only turned out a little better due to what happened in the next five years. It could've also turned out worse in a different environment. At the time of purchase no one knew.
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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by rnitz » Sun Aug 26, 2018 8:08 pm

jalbert wrote:
Sun Aug 26, 2018 7:06 pm
The original premise that TIPS are purported to be an inflation hedge is not correct. That is too strong of a term. TIPS diversify the risk of inflation being higher than the market expects. They do not eliminate the risk.

In fact, they only attempt to eliminate the risk in themselves. Nominal treasuries have inflation risk and term risk. With TIPS the inflation risk of the bonds goes away but you still have term risk.

TIPS certainly do not hedge any inflation risk in other assets held.
I second this comment (not that jalbert needs any "seconding"). TIPS aren't "insurance", they are a different type of bond. Nominal bonds (and funds) have nominal interest rate risk. TIPS (and TIPS funds) have real interest rate risk. I invest in TIPS for interest rate diversification (as well as many of the other already discussed factors).

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by Noobvestor » Sun Aug 26, 2018 8:37 pm

aristotelian wrote:
Sun Aug 26, 2018 4:46 pm
willthrill81 wrote:
Sun Aug 26, 2018 4:18 pm

Negative returns are a result of negative yield. The initial yields on short-term TIPS offered a few years ago were negative, hence the negative returns down the line.

This FED web page demonstrates this. Five year TIPS had negative real yields (very briefly) as recently as June, 2017.
Thanks for trying. I still don't get it. VG data says the fund had negative capital appreciation and this was the main source of negative total return in 2013-14. I will just stay away and buy TIPS directly rather than through a fund if I ever decide to go that route. IMO, negative returns during positive inflation does not seem like very good inflation protection!
This is always a risk with a fund, but not a reason to avoid funds entirely unless your time horizon is short. Part of what drove the negative real return over that period was the negative yield at the start of that period. Over time, NAV fluctuations tend to have less of an impact over time.

Note that you could have bought TIPS individually (outside a fund) with a negative real yield, and you'd have gotten negative real returns during 'positive inflation' too (I'm not sure what you mean by that, but it doesn't really matter in real-dollar terms).

I've been buying I Bonds for years at 0% real return. Why? Because I want to hedge inflation, even if my post-tax return is slightly negative. Right now you can buy TIPS with positive yields, but I wouldn't suggest avoiding them arbitrarily when they have negative real yields.
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by FIREchief » Sun Aug 26, 2018 8:47 pm

willthrill81 wrote:
Sun Aug 26, 2018 6:02 pm
I do not doubt at all that you experienced a difference between purchasing individual TIPS versus a TIPS fund. That is also true of nominal bonds. But the return of Vanguard's TIPS fund versus their short-term Treasury fund with the exact same average effective maturity is undeniable.
I've experienced no such thing, as I don't buy TIPS funds.

That said, do you really still believe that a person buying an individual TIPS is forfeiting 30 basis points of real return for protection from unexpected high inflation? :confused
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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by hdas » Sun Aug 26, 2018 9:08 pm

ok, I'm an ignoramus on this topic. But looking at portfolio visualizer:

Portfolio1 - ishares TIP
Portfolio2 - ishares AGG

Seems like this particular TIP fund does well relative to nominal bond fund over the period 2004-2018. Both funds have similar avg weighted duration. Where's the catch, what I'm I missing?.

Image

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by willthrill81 » Sun Aug 26, 2018 9:18 pm

FIREchief wrote:
Sun Aug 26, 2018 8:47 pm
willthrill81 wrote:
Sun Aug 26, 2018 6:02 pm
I do not doubt at all that you experienced a difference between purchasing individual TIPS versus a TIPS fund. That is also true of nominal bonds. But the return of Vanguard's TIPS fund versus their short-term Treasury fund with the exact same average effective maturity is undeniable.
I've experienced no such thing, as I don't buy TIPS funds.

That said, do you really still believe that a person buying an individual TIPS is forfeiting 30 basis points of real return for protection from unexpected high inflation? :confused
I haven't attempted to price out the difference between TIPS and Treasury bonds of similar duration. I only demonstrated the difference over the past five years with five year TIPS and short-term Treasuries.
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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by willthrill81 » Sun Aug 26, 2018 9:24 pm

PriceOfFreedom wrote:
Sat Aug 25, 2018 11:56 pm
I keep reading that TIPS are an inflation hedge, and that short-term TIPS are less sensitive to interest rate changes and so are closer to a "pure" short-term inflation hedge than longer term TIPS.

Where I am confused is when I examine the return record of Vanguard's Short-Term TIPS Fund (VTAPX). In examining the full years the fund has been in operation, I retrieved the total return from the Vanguard web site, and also computed the CPI increase from the BLS site. Here's what I computed (starting with an arbitraty real value of 100 at the end of 2012:

VTAPX Tot Return CPI Real Return Real Value
2013 -1.54% 1.50% -3.00% 97.00
2014 -1.18% 0.76% -1.92% 95.14
2015 -0.17% 0.73% -0.89% 94.29
2016 2.72% 2.07% +0.63% 94.89
2017 0.82% 2.11% -1.26% 93.69

So for the five full years of operation, VTAPX appears to have lost 6.31% of its real value.

Where's the inflation hedge?
The short answer is in this graph. For a significant chunk of the last five years, TIPS yields were negative. This was known at the time of purchase. Negative yields equal negative returns.

Image
https://fred.stlouisfed.org/series/DFII5
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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by FIREchief » Sun Aug 26, 2018 10:08 pm

willthrill81 wrote:
Sun Aug 26, 2018 3:28 pm
Let's compare VTAPX, Vanguard's short-term TIPS fund, to their short-term Treasuries fund, VFIRX, which currently has the same average effective maturity. Since Jan., 2013, VTAPX has had a real CAGR of -1.46% vs. VFIRX's -1.16%. That .30% lower return for VTAPX was the 'premium' paid for the TIPS' 'insurance'.
Let's dig a bit more into your numbers for these two funds. I'm just looking at the average annual returns on the Vanguard web page for each fund:

3 years:
VTAPX (short term TIPS): 1.10% annual return
VFIIRX (short term nominal treasury): 0.40% return

1 year:
VTAPX (short term TIPS): 0.90% annual return
VFIIRX (short term nominal treasury): -0.51% return

Do you still think that buyer of the TIPS fund is wasting a return amounting to 0.30% "premium paid for TIPS insurance?" If we follow your reasoning immediately quoted above it sounds like, over the past three years, that the TIPS buyer was paying a negative .70% "premium for TIPS insurance."

You may wish to reconsider this whole line of reasoning, as I don't think it is supporting your position very well. For one thing, you've failed to consider the differences between the breakeven inflation rates upon the purchase of each bond in comparison to the realized inflation rates during the time the bond is held. This (which is next to impossible to do for a comparison of mutual funds each holding many bonds that won't match the maturity dates and terms of the bonds in the other) would establish to what extent the "insurance" has actually paid off. If we accept your premise that a TIPS buyer pays a 0.30% premium for TIPS insurance, then that 3 year buyer in my numbers above actually received an insurance payout of 1.00% in return each year. I'll pay 30 cents for insurance that pays out a buck to me each year as often as I can. :beer

Also, if I am willing to accept that a TIPS mutual fund can be compared to a nominal fund in any meaningful way, then I'm hoping you will agree that the funds should have the same durations. In the case of the two funds you brought up, the TIPS fund currently has a published duration that is 27% longer than the nominal treasury fund. I'm sure you'll agree that a fund with longer duration will be more negatively impacted by rising rates (which has been the case for both real and nominal rates during any of the time periods we've discussed).
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by willthrill81 » Mon Aug 27, 2018 12:17 am

FIREchief wrote:
Sun Aug 26, 2018 10:08 pm
willthrill81 wrote:
Sun Aug 26, 2018 3:28 pm
Let's compare VTAPX, Vanguard's short-term TIPS fund, to their short-term Treasuries fund, VFIRX, which currently has the same average effective maturity. Since Jan., 2013, VTAPX has had a real CAGR of -1.46% vs. VFIRX's -1.16%. That .30% lower return for VTAPX was the 'premium' paid for the TIPS' 'insurance'.
Let's dig a bit more into your numbers for these two funds. I'm just looking at the average annual returns on the Vanguard web page for each fund:

3 years:
VTAPX (short term TIPS): 1.10% annual return
VFIIRX (short term nominal treasury): 0.40% return

1 year:
VTAPX (short term TIPS): 0.90% annual return
VFIIRX (short term nominal treasury): -0.51% return

Do you still think that buyer of the TIPS fund is wasting a return amounting to 0.30% "premium paid for TIPS insurance?" If we follow your reasoning immediately quoted above it sounds like, over the past three years, that the TIPS buyer was paying a negative .70% "premium for TIPS insurance."

You may wish to reconsider this whole line of reasoning, as I don't think it is supporting your position very well. For one thing, you've failed to consider the differences between the breakeven inflation rates upon the purchase of each bond in comparison to the realized inflation rates during the time the bond is held. This (which is next to impossible to do for a comparison of mutual funds each holding many bonds that won't match the maturity dates and terms of the bonds in the other) would establish to what extent the "insurance" has actually paid off. If we accept your premise that a TIPS buyer pays a 0.30% premium for TIPS insurance, then that 3 year buyer in my numbers above actually received an insurance payout of 1.00% in return each year. I'll pay 30 cents for insurance that pays out a buck to me each year as often as I can. :beer

Also, if I am willing to accept that a TIPS mutual fund can be compared to a nominal fund in any meaningful way, then I'm hoping you will agree that the funds should have the same durations. In the case of the two funds you brought up, the TIPS fund currently has a published duration that is 27% longer than the nominal treasury fund. I'm sure you'll agree that a fund with longer duration will be more negatively impacted by rising rates (which has been the case for both real and nominal rates during any of the time periods we've discussed).
What I reported is not a 'premise'; it was the actual numbers. And I said that the two funds currently have the same average effective maturity, not duration.

You seem to be arguing that there is a free lunch with TIPS in the form of the insurance they provide not costing you anything.
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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by FIREchief » Mon Aug 27, 2018 12:28 am

willthrill81 wrote:
Mon Aug 27, 2018 12:17 am
FIREchief wrote:
Sun Aug 26, 2018 10:08 pm
willthrill81 wrote:
Sun Aug 26, 2018 3:28 pm
Let's compare VTAPX, Vanguard's short-term TIPS fund, to their short-term Treasuries fund, VFIRX, which currently has the same average effective maturity. Since Jan., 2013, VTAPX has had a real CAGR of -1.46% vs. VFIRX's -1.16%. That .30% lower return for VTAPX was the 'premium' paid for the TIPS' 'insurance'.
Let's dig a bit more into your numbers for these two funds. I'm just looking at the average annual returns on the Vanguard web page for each fund:

3 years:
VTAPX (short term TIPS): 1.10% annual return
VFIIRX (short term nominal treasury): 0.40% return

1 year:
VTAPX (short term TIPS): 0.90% annual return
VFIIRX (short term nominal treasury): -0.51% return

Do you still think that buyer of the TIPS fund is wasting a return amounting to 0.30% "premium paid for TIPS insurance?" If we follow your reasoning immediately quoted above it sounds like, over the past three years, that the TIPS buyer was paying a negative .70% "premium for TIPS insurance."

You may wish to reconsider this whole line of reasoning, as I don't think it is supporting your position very well. For one thing, you've failed to consider the differences between the breakeven inflation rates upon the purchase of each bond in comparison to the realized inflation rates during the time the bond is held. This (which is next to impossible to do for a comparison of mutual funds each holding many bonds that won't match the maturity dates and terms of the bonds in the other) would establish to what extent the "insurance" has actually paid off. If we accept your premise that a TIPS buyer pays a 0.30% premium for TIPS insurance, then that 3 year buyer in my numbers above actually received an insurance payout of 1.00% in return each year. I'll pay 30 cents for insurance that pays out a buck to me each year as often as I can. :beer

Also, if I am willing to accept that a TIPS mutual fund can be compared to a nominal fund in any meaningful way, then I'm hoping you will agree that the funds should have the same durations. In the case of the two funds you brought up, the TIPS fund currently has a published duration that is 27% longer than the nominal treasury fund. I'm sure you'll agree that a fund with longer duration will be more negatively impacted by rising rates (which has been the case for both real and nominal rates during any of the time periods we've discussed).
What I reported is not a 'premise'; it was the actual numbers. And I said that the two funds currently have the same average effective maturity, not duration.

You seem to be arguing that there is a free lunch with TIPS in the form of the insurance they provide not costing you anything.
According to the website, they most definitely do NOT have the same average effective maturity. It is 2.8 vs. 2.2. Same percentage difference as their duration numbers, which are what are commonly looked at for comparison purposes. Are you seeing something different? And I was also reporting actual numbers, just not cherry picking.

TIPS have been giving us a free lunch. I personally believe it is because of the ignorance of retail investors who just can't get their minds around real vs. nominal rates. But, that's just one man's opinion.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by willthrill81 » Mon Aug 27, 2018 12:33 am

FIREchief wrote:
Mon Aug 27, 2018 12:28 am
willthrill81 wrote:
Mon Aug 27, 2018 12:17 am
FIREchief wrote:
Sun Aug 26, 2018 10:08 pm
willthrill81 wrote:
Sun Aug 26, 2018 3:28 pm
Let's compare VTAPX, Vanguard's short-term TIPS fund, to their short-term Treasuries fund, VFIRX, which currently has the same average effective maturity. Since Jan., 2013, VTAPX has had a real CAGR of -1.46% vs. VFIRX's -1.16%. That .30% lower return for VTAPX was the 'premium' paid for the TIPS' 'insurance'.
Let's dig a bit more into your numbers for these two funds. I'm just looking at the average annual returns on the Vanguard web page for each fund:

3 years:
VTAPX (short term TIPS): 1.10% annual return
VFIIRX (short term nominal treasury): 0.40% return

1 year:
VTAPX (short term TIPS): 0.90% annual return
VFIIRX (short term nominal treasury): -0.51% return

Do you still think that buyer of the TIPS fund is wasting a return amounting to 0.30% "premium paid for TIPS insurance?" If we follow your reasoning immediately quoted above it sounds like, over the past three years, that the TIPS buyer was paying a negative .70% "premium for TIPS insurance."

You may wish to reconsider this whole line of reasoning, as I don't think it is supporting your position very well. For one thing, you've failed to consider the differences between the breakeven inflation rates upon the purchase of each bond in comparison to the realized inflation rates during the time the bond is held. This (which is next to impossible to do for a comparison of mutual funds each holding many bonds that won't match the maturity dates and terms of the bonds in the other) would establish to what extent the "insurance" has actually paid off. If we accept your premise that a TIPS buyer pays a 0.30% premium for TIPS insurance, then that 3 year buyer in my numbers above actually received an insurance payout of 1.00% in return each year. I'll pay 30 cents for insurance that pays out a buck to me each year as often as I can. :beer

Also, if I am willing to accept that a TIPS mutual fund can be compared to a nominal fund in any meaningful way, then I'm hoping you will agree that the funds should have the same durations. In the case of the two funds you brought up, the TIPS fund currently has a published duration that is 27% longer than the nominal treasury fund. I'm sure you'll agree that a fund with longer duration will be more negatively impacted by rising rates (which has been the case for both real and nominal rates during any of the time periods we've discussed).
What I reported is not a 'premise'; it was the actual numbers. And I said that the two funds currently have the same average effective maturity, not duration.

You seem to be arguing that there is a free lunch with TIPS in the form of the insurance they provide not costing you anything.
According to the website, they most definitely do NOT have the same average effective maturity. It is 2.8 vs. 2.2. Same percentage difference as their duration numbers, which are what are commonly looked at for comparison purposes. Are you seeing something different? And I was also reporting actual numbers, just not cherry picking.
I stand corrected. I was looking at the benchmark for VFIRX and not the fund itself.
FIREchief wrote:
Mon Aug 27, 2018 12:28 am
TIPS have been giving us a free lunch. I personally believe it is because of the ignorance of retail investors who just can't get their minds around real vs. nominal rates. But, that's just one man's opinion.
That may be, but good luck convincing believers in the EMH that such an 'inefficiency' exists.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by FIREchief » Mon Aug 27, 2018 12:40 am

willthrill81 wrote:
Mon Aug 27, 2018 12:33 am
FIREchief wrote:
Mon Aug 27, 2018 12:28 am
TIPS have been giving us a free lunch. I personally believe it is because of the ignorance of retail investors who just can't get their minds around real vs. nominal rates. But, that's just one man's opinion.
That may be, but good luck convincing believers in the EMH that such an 'inefficiency' exists.
I guess I'm among the believers in EMH, but likely not a "zealot."

At the end of the day, I currently see TIPS as an excellent choice for my LMP. If there is a premium for the inflation protection, it is small and a price I am willing to pay, considering how I am using them.

EMH will always have a lot of noise, much of which may be attributed to retail investors who bring both emotion and lack of basic math skills to the table. At times like this, it may provide guys like me with a free lunch. I'll dig in and understand that nothing lasts forever. :beer
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by jalbert » Mon Aug 27, 2018 2:24 am

hdas wrote:
Sun Aug 26, 2018 9:08 pm
ok, I'm an ignoramus on this topic. But looking at portfolio visualizer:

Portfolio1 - ishares TIP
Portfolio2 - ishares AGG

Seems like this particular TIP fund does did well relative to nominal bond fund over the period 2004-2018. Both funds have similar avg weighted duration. Where's the catch, what I'm I missing?.

Image
See correction above. TIP is an excellent fund. One way to interpret the chart is that TIP did slightly better than AGG over the time period. Another way to interpret the chart is that TIP assumed a similar result but with more volatility.

Deciding which bond fund is appropriate for a given portfolio role might be based on the personal circumstances of the investor and what the purpose of the bond fund might be in the portfolio.
Risk is not a guarantor of return.

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by hdas » Mon Aug 27, 2018 8:25 am

hdas wrote:
Sun Aug 26, 2018 9:08 pm
ok, I'm an ignoramus on this topic. But looking at portfolio visualizer:

Portfolio1 - ishares TIP
Portfolio2 - ishares AGG

Seems like this particular TIP fund does well relative to nominal bond fund over the period 2004-2018. Both funds have similar avg weighted duration. Where's the catch, what I'm I missing?.

Image
To alleviate my ignorance, a cursory search yielded a very nice precis on the topic:

An Introduction to Inflation-Linked Bonds: http://www.lazardnet.com/docs/sp0/6034/ ... search.pdf

This is the key quote:

"The yield that is quoted for linkers in trading is not the regular yield to maturity, but instead is stated on a real basis. This real yield is rate the inflation expected by the market over the term of the bonds(ignoring liquidity and risk premiums).

The concept of duration can also be applied (if slightly adjusted) to inflation-linked bonds. But if it is intended that the duration be used as a measure of interest rate risk (as in traditional bonds), one should keep in mind that, as noted by Bowler (2001), in traditional bonds, duration represents an approximation of bond price change in the event of a change in nominal yields. For inflation-linked bonds, duration represents the price change when there is a change in real yields.

What is the duration of inflation-indexed bonds compared to traditional bonds, and what is the price sensitivity of different types of bonds? As we have learned, the coupons of inflation-linked bonds are (assuming equal real income) substantially smaller than those of traditional bonds, whereas the principal repayment is larger. Thus, the duration of an inflation-linked bond is greater than that of a comparable traditional bond (Hammond 2002).

However, that does not mean that the risk of price change would therefore also be greater. This is because the price-determining quantity of the linker, the real interest rate, is—as history shows—much less volatile than the price-determining quantity of the traditional bond, the nominal interest rate. Thus, the inflation-linked bond is more closely tied to changes in real interest than traditional bonds are tied to changes in nominal interest, but since real interest is much less volatile than nominal interest, it is ultimately apparent that the price-volatility of ten-year linkers is approximately only as great as that of four- to five-year traditional bonds. Thus, a linker’s duration is not a measure of risk for the purpose of comparing them with traditional bonds, but is instead merely a measure of the risk of linkers alone."


Cheers :greedy

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by Phineas J. Whoopee » Mon Aug 27, 2018 10:31 am

FIREchief wrote:
Mon Aug 27, 2018 12:40 am
...
EMH will always have a lot of noise, much of which may be attributed to retail investors who bring both emotion and lack of basic math skills to the table. At times like this, it may provide guys like me with a free lunch. I'll dig in and understand that nothing lasts forever. :beer
The Efficient Market Hypothesis does not predict perfect pricing. There isn't and can't be such a thing.

I wrote about it here.

PJW

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by jalbert » Tue Aug 28, 2018 12:44 am

EMH will always have a lot of noise, much of which may be attributed to retail investors who bring both emotion and lack of basic math skills to the table. 
That is far from clear. It is unclear that retail investors move the market at all. The market prices in information probabilistically, with constant revision as more information is revealed. It is generally impossible to know whether something priced in probabilistically is priced accurately or mispriced.
Risk is not a guarantor of return.

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by Angst » Wed Aug 29, 2018 9:17 am

hdas wrote:
Mon Aug 27, 2018 8:25 am
An Introduction to Inflation-Linked Bonds: http://www.lazardnet.com/docs/sp0/6034/ ... search.pdf

This is the key quote:

"The yield that is quoted for linkers in trading is not the regular yield to maturity, but instead is stated on a real basis. This real yield is rate the inflation expected by the market over the term of the bonds(ignoring liquidity and risk premiums).

The concept of duration can also be applied (if slightly adjusted) to inflation-linked bonds. But if it is intended that the duration be used as a measure of interest rate risk (as in traditional bonds), one should keep in mind that, as noted by Bowler (2001), in traditional bonds, duration represents an approximation of bond price change in the event of a change in nominal yields. For inflation-linked bonds, duration represents the price change when there is a change in real yields.

However, that does not mean that the risk of price change would therefore also be greater. This is because the price-determining quantity of the linker, the real interest rate, is—as history shows—much less volatile than the price-determining quantity of the traditional bond, the nominal interest rate. Thus, the inflation-linked bond is more closely tied to changes in real interest than traditional bonds are tied to changes in nominal interest, but since real interest is much less volatile than nominal interest, it is ultimately apparent that the price-volatility of ten-year linkers is approximately only as great as that of four- to five-year traditional bonds. Thus, a linker’s duration is not a measure of risk for the purpose of comparing them with traditional bonds, but is instead merely a measure of the risk of linkers alone."

Cheers :greedy
Thanks hdas for posting the link to this pdf and for the quote in particular. The overall point, concluded in the last paragraph (my underlining), has been made in the forum before but it bears repeating, frequently. People casually talk about TIPS duration and nominals duration in the same breath as if they were one and the same dynamic, but they're not. They differ in multiple dimensions, and this must be kept in mind. Thanks again for reminding everyone.

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by FIREchief » Wed Aug 29, 2018 2:32 pm

Angst wrote:
Wed Aug 29, 2018 9:17 am
hdas wrote:
Mon Aug 27, 2018 8:25 am
An Introduction to Inflation-Linked Bonds: http://www.lazardnet.com/docs/sp0/6034/ ... search.pdf

This is the key quote:

"The yield that is quoted for linkers in trading is not the regular yield to maturity, but instead is stated on a real basis. This real yield is rate the inflation expected by the market over the term of the bonds(ignoring liquidity and risk premiums).

The concept of duration can also be applied (if slightly adjusted) to inflation-linked bonds. But if it is intended that the duration be used as a measure of interest rate risk (as in traditional bonds), one should keep in mind that, as noted by Bowler (2001), in traditional bonds, duration represents an approximation of bond price change in the event of a change in nominal yields. For inflation-linked bonds, duration represents the price change when there is a change in real yields.

However, that does not mean that the risk of price change would therefore also be greater. This is because the price-determining quantity of the linker, the real interest rate, is—as history shows—much less volatile than the price-determining quantity of the traditional bond, the nominal interest rate. Thus, the inflation-linked bond is more closely tied to changes in real interest than traditional bonds are tied to changes in nominal interest, but since real interest is much less volatile than nominal interest, it is ultimately apparent that the price-volatility of ten-year linkers is approximately only as great as that of four- to five-year traditional bonds. Thus, a linker’s duration is not a measure of risk for the purpose of comparing them with traditional bonds, but is instead merely a measure of the risk of linkers alone."

Cheers :greedy
Thanks hdas for posting the link to this pdf and for the quote in particular. The overall point, concluded in the last paragraph (my underlining), has been made in the forum before but it bears repeating, frequently. People casually talk about TIPS duration and nominals duration in the same breath as if they were one and the same dynamic, but they're not. They differ in multiple dimensions, and this must be kept in mind. Thanks again for reminding everyone.
Yes, thank you. I tried to make the same point earlier in the thread, but as I mentioned at that time I didn't really have the links to back it up.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by hdas » Wed Sep 05, 2018 6:13 am

FIREchief wrote:
Wed Aug 29, 2018 2:32 pm
Yes, thank you. I tried to make the same point earlier in the thread, but as I mentioned at that time I didn't really have the links to back it up.
Can somebody elaborate on why ppl don't hold tip funds instead of nominal treasury funds?....specially in light of the empirical performance. It seems that the cost of the inflation insurance is not too excessive:

Portfolio 1: ishares TIP
Portfolio 2: ishares IEF

Image

Thanks

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Re: Where's the Inflation Hedge for Short-Term TIPS?

Post by FIREchief » Wed Sep 05, 2018 1:09 pm

hdas wrote:
Wed Sep 05, 2018 6:13 am
FIREchief wrote:
Wed Aug 29, 2018 2:32 pm
Yes, thank you. I tried to make the same point earlier in the thread, but as I mentioned at that time I didn't really have the links to back it up.
Can somebody elaborate on why ppl don't hold tip funds instead of nominal treasury funds?....specially in light of the empirical performance. It seems that the cost of the inflation insurance is not too excessive:
There is much evidence that the current cost of "inflation insurance" for TIPS is at or very close to zero. The fact that the insurance has paid off (and paid off higher than the premium paid) of the past year or so makes it even harder to argue against. (see earlier posts in this thread for further explanation).

The only reason I don't buy TIPS funds is that I prefer to buy and hold individual TIPS for liability matching purposes (i.e. LMP).
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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