TIPS funds

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Gufomel
Posts: 386
Joined: Sat Feb 14, 2015 9:52 pm

TIPS funds

Post by Gufomel » Wed Mar 25, 2020 4:13 pm

I think I have at least a basic understanding of how TIPS work, but I’m struggling with understanding how a TIPS fund works and what to expect from yield and price movement based on changes in interest rates and inflation.

First of all, the Vanguard Short Term TIPS fund (VTAPX) has a 30-day SEC yield of negative 0.23%. I’m struggling processing what that even means. Is that the same thing as if a nominal bond fund had negative yield? Or is there some inflation adjustment that’s not being factored in there?

If inflation rises (or inflation is expected to rise), what impact does this have on the yield and price of the fund? I understand how yield/price works for bonds, but for some reason the inflation component is throwing me off. I’m assuming rising inflation is positive for someone who holds TIPS?

If I’m not mistaken, generally rising inflation is correlated with rising interest rates, so although holding a TIPS fund would protect to you from rising inflation, the fund would still lose value similar to a nominal bond fund?

Topic Author
Gufomel
Posts: 386
Joined: Sat Feb 14, 2015 9:52 pm

Re: TIPS funds

Post by Gufomel » Wed Mar 25, 2020 4:30 pm

I also noticed that the breakeven inflation rate is currently very low. Does that mean TIPS are “cheap” right now? Not in the sense that you can predict that it’s a better investment than another alternative, but in the sense that because expectations for inflation are so low, there’s some upside in holding TIPS if inflation does rise more than expected? And if inflation does rise more than expected, a TIPS fund price would increase? Just trying to make sure I understand the logic.

https://ycharts.com/indicators/5_year_t ... keven_rate

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Phineas J. Whoopee
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Re: TIPS funds

Post by Phineas J. Whoopee » Wed Mar 25, 2020 6:59 pm

The negative yield is inflation-adjusted, yes. Homework: what is the expected real yield for nominal Treasuries of similar duration?

TIPS are exposed to real yields, not nominal. An increase in nominal yields won't, in and of itself, affect TIPS market prices.

I don't know, because no one does, but I should think probably that if unexpected inflation shows up demand for TIPS will rise, which will put downward pressure on their real yields.

TIPS funds behave exactly the same as your portfolio would if you held TIPS of the same maturities in the same proportions. A mutual fund is nothing more nor less than a way to own its underlying holdings.

The reason to buy TIPS with negative real yields is there's a known real loss, which can be planned around. With nominal Treasuries the potential real gain or loss is unknown, and can't be planned around. Not all investors will find that reasoning compelling. It's OK. That's what makes a market.

Does that help?

PJW

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