Do TIPS work? How do we know?

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Horton
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Re: Do TIPS work? How do we know?

Post by Horton » Tue Jan 07, 2020 2:06 pm

SlowMovingInvestor wrote:
Tue Jan 07, 2020 1:33 pm
Horton wrote:
Mon Jan 06, 2020 12:36 pm

Even more interesting that TIP took a -8.65% hit in 2013. What was the reason for that ? Fed actions ?

Interest rates increased. Also, breakeven inflation rates decreased. So basically real rates increased more than nominal rates.
That's just the definition of breakeven inflation rates, right ? I guess I was asking more what economic or market conditions lead to the divergence. Is it the case that actual inflation was lower than expected inflation ?

[I'm still a little confused by TIPS, so please excuse any silly questions]
The primary driver is changes in interest rates. The comment about breakeven inflation was intended to draw a distinction between real and nominal rates, in case you were comparing the 2013 return of TIP to say a Total Bond fund.

When evaluating returns I think you would primary want to consider:

- changes in interest rates (real or nominal)
- duration of the fund (higher duration produces greater changes due to interest rate changes)
- breakeven inflation (e.g., 10 yr real rate + 10 yr breakeven inflation = 10 yr nominal rate)

You could also look at actual inflation compared to breakeven.

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Horton
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Re: Do TIPS work? How do we know?

Post by Horton » Tue Jan 07, 2020 2:10 pm

typical.investor wrote:
Tue Jan 07, 2020 2:05 pm
FactualFran wrote:
Sat Dec 14, 2019 12:44 pm
kadye wrote:
Sat Dec 14, 2019 12:24 pm
I read elsewhere that the historical correlation between TIPS and CPI has been very very low. Can someone please illuminate us why this is?
Without knowing exactly what you read elsewhere, it is not possible to determine whether what you read elsewhere is accurate.

On possibility is that because 1) the principle of TIPS is adjusted using the CPI-U from a few months before the adjustment and 2) month-to-month changes in the CPI-U can have a very low correlation, there can be a very low correlation between the principle of TIPS and the most recent CPI-U.
Longer dated TIPS are not correlated to inflation. Shorter dated ones are.

It has nothing to do with CPI-U and how it’s calculated.

It’s basic bond math.
All this is apples and oranges.

Of course Intermediate/Long TIPS don’t perfectly correlate with ST inflation due to fluctuations in the market value due to interest rate changes. But, an intermediate TIPS fund should have very tight correlation with inflation over a 7-10 period.
Last edited by Horton on Tue Jan 07, 2020 3:06 pm, edited 2 times in total.

typical.investor
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Re: Do TIPS work? How do we know?

Post by typical.investor » Tue Jan 07, 2020 2:29 pm

Horton wrote:
Tue Jan 07, 2020 2:10 pm
typical.investor wrote:
Tue Jan 07, 2020 2:05 pm
FactualFran wrote:
Sat Dec 14, 2019 12:44 pm
kadye wrote:
Sat Dec 14, 2019 12:24 pm
I read elsewhere that the historical correlation between TIPS and CPI has been very very low. Can someone please illuminate us why this is?
Without knowing exactly what you read elsewhere, it is not possible to determine whether what you read elsewhere is accurate.

On possibility is that because 1) the principle of TIPS is adjusted using the CPI-U from a few months before the adjustment and 2) month-to-month changes in the CPI-U can have a very low correlation, there can be a very low correlation between the principle of TIPS and the most recent CPI-U.
Longer dated TIPS are not correlated to inflation. Shorter dated ones are.

It has nothing to do with CPI-U and how it’s calculated.

It’s basic bond math.
All this is apples and oranges.

Of course Intermediate/Long TIPS don’t perfectly correlate with ST inflation due to fluctuations in the market value due to interest rate changes. But, an intermediate TIPS fund should have very tight correlation with inflation over a 7-10 period.

Yes, a 10 year TIPS will correlate with inflation over ab10?year period, I disagree that is necessarily true for bond funds.

If a bond fund you bought with a 7 year duration sees spiking rates (inflation), in the 5 -7 year mark of your holding period, then no you won’t have tight correlation at year 7.

This is as the bond fund’s duration is kept constant while an individual bond’s duration is decreasing.

Thus the NAV loss the bond fund suffers will uncouple its correlation with inflation until it hits the recovery mark which is its duration of 7 years.

Again, short term and individual TIPS are of course different.

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Horton
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Re: Do TIPS work? How do we know?

Post by Horton » Tue Jan 07, 2020 2:34 pm

The key is to match your interest rate and inflation exposure to your investment horizon. A TIPS ladder does this. A duration matching strategy using TIPS funds does this when the investor matches the duration to the desired horizon, which, to your point, may decrease over time.

SlowMovingInvestor
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Re: Do TIPS work? How do we know?

Post by SlowMovingInvestor » Tue Jan 07, 2020 2:36 pm

I don't think I phrased my earlier queries very well. So as a TIPS novice, let me rephrase.

Under what circumstances would a TIPS fund (not individual securities) do worse than a regular Treasury fund with the same duration/maturity ?

One obvious answer is when there is a massive liquidity premium (as in 2008). Other circumstances ? If actual inflation comes in lower than expected ?
,

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Horton
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Re: Do TIPS work? How do we know?

Post by Horton » Tue Jan 07, 2020 2:41 pm

SlowMovingInvestor wrote:
Tue Jan 07, 2020 2:36 pm
I don't think I phrased my earlier queries very well. So as a TIPS novice, let me rephrase.

Under what circumstances would a TIPS fund (not individual securities) do worse than a regular Treasury fund with the same duration/maturity ?

One obvious answer is when there is a massive liquidity premium (as in 2008). Other circumstances ? If actual inflation comes in lower than expected ?
,
Deflation/disinflation is probably where the biggest difference would occur.

Conversely, higher than expected inflationary environments are where Treasury funds would do worse than a TIPS fund.

SlowMovingInvestor
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Re: Do TIPS work? How do we know?

Post by SlowMovingInvestor » Tue Jan 07, 2020 6:01 pm

Horton wrote:
Tue Jan 07, 2020 2:41 pm
SlowMovingInvestor wrote:
Tue Jan 07, 2020 2:36 pm
I don't think I phrased my earlier queries very well. So as a TIPS novice, let me rephrase.

Under what circumstances would a TIPS fund (not individual securities) do worse than a regular Treasury fund with the same duration/maturity ?

One obvious answer is when there is a massive liquidity premium (as in 2008). Other circumstances ? If actual inflation comes in lower than expected ?
,
Deflation/disinflation is probably where the biggest difference would occur.

Conversely, higher than expected inflationary environments are where Treasury funds would do worse than a TIPS fund.
And would you expect TIPS funds to perform about as well (or as badly) as a single TIPS security of about the same duration ?

typical.investor
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Re: Do TIPS work? How do we know?

Post by typical.investor » Tue Jan 07, 2020 6:16 pm

SlowMovingInvestor wrote:
Tue Jan 07, 2020 6:01 pm
Horton wrote:
Tue Jan 07, 2020 2:41 pm
SlowMovingInvestor wrote:
Tue Jan 07, 2020 2:36 pm
I don't think I phrased my earlier queries very well. So as a TIPS novice, let me rephrase.

Under what circumstances would a TIPS fund (not individual securities) do worse than a regular Treasury fund with the same duration/maturity ?

One obvious answer is when there is a massive liquidity premium (as in 2008). Other circumstances ? If actual inflation comes in lower than expected ?
,
Deflation/disinflation is probably where the biggest difference would occur.

Conversely, higher than expected inflationary environments are where Treasury funds would do worse than a TIPS fund.
And would you expect TIPS funds to perform about as well (or as badly) as a single TIPS security of about the same duration ?
Horton will say the same. We have had this conversation before.

I say the TIPS fund may perform worse if you are spending out of it in a rising rate environment. Take Vanguard's Short-Term TIPS fund for instance; it has a duration of 2.5 years. If rates rise 1%, you will have 2.5% in NAV loss. If you are selling to fund expenses, the amount you spend will be at a 2.5% loss (only the amount you spend - I do not mean a 2.5% loss on your portfolio) because the bonds will not have time to recover. If you have an individual bond ladder, this will not happen.

Horton insists that if your retirement duration is 10 years, that you will have equal results to individual holdings by using a mix of funds that together average 10 years. So he says returns will be the same.

I disagree because as I pointed out, you will be most likely selling out of a fund that has a multi-year duration (even if it is short term) and thus more vulnerable to a rising rate environment.

This is one reason why Vanguard uses international bonds. The reasoning is that inflation is regional, so inflation in the US may not equate NAV loss in foreign bonds. Well, we have seen inflation drop globally. I suspect that if it reoccurs, it may be global.

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Phineas J. Whoopee
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Re: Do TIPS work? How do we know?

Post by Phineas J. Whoopee » Tue Jan 07, 2020 6:29 pm

abuss368 wrote:
Mon Jan 06, 2020 10:54 pm
Northern Flicker wrote:
Mon Jan 06, 2020 6:36 pm
Personal inflation rate would have been a better term.
Individuals can have Personal inflation. Consider someone younger compared to a student in college and compared to a retiree with large medical expenses.
That's precisely what inflation is not. It is, however, a change of personal expenditures.

PJW

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Horton
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Re: Do TIPS work? How do we know?

Post by Horton » Tue Jan 07, 2020 6:35 pm

SlowMovingInvestor wrote:
Tue Jan 07, 2020 6:01 pm
Horton wrote:
Tue Jan 07, 2020 2:41 pm
SlowMovingInvestor wrote:
Tue Jan 07, 2020 2:36 pm
I don't think I phrased my earlier queries very well. So as a TIPS novice, let me rephrase.

Under what circumstances would a TIPS fund (not individual securities) do worse than a regular Treasury fund with the same duration/maturity ?

One obvious answer is when there is a massive liquidity premium (as in 2008). Other circumstances ? If actual inflation comes in lower than expected ?
,
Deflation/disinflation is probably where the biggest difference would occur.

Conversely, higher than expected inflationary environments are where Treasury funds would do worse than a TIPS fund.
And would you expect TIPS funds to perform about as well (or as badly) as a single TIPS security of about the same duration ?
It’s all in the details. If you compare a single 10 year TIPS to a mix of a short and intermediate term TIPS fund where the duration is matched to the individual TIPS security (i.e., it starts around 7-8 and glides down to the duration of the short term fund over the 10 period), then I would expect them to be very similar.

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abuss368
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Re: Do TIPS work? How do we know?

Post by abuss368 » Tue Jan 07, 2020 6:49 pm

Personal inflation can definitely have impact. Inflation can have a larger or smaller impact depending on individual circumstances. This is widely known.
John C. Bogle - Two Fund Portfolio: Total Stock & Total Bond. "Simplicity is the master key to financial success." || Buy Total Stock until it hurts. Then find a way to buy even more!

SlowMovingInvestor
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Re: Do TIPS work? How do we know?

Post by SlowMovingInvestor » Tue Jan 07, 2020 6:53 pm

typical.investor wrote:
Tue Jan 07, 2020 6:16 pm

I say the TIPS fund may perform worse if you are spending out of it in a rising rate environment. Take Vanguard's Short-Term TIPS fund for instance; it has a duration of 2.5 years. If rates rise 1%, you will have 2.5% in NAV loss. If you are selling to fund expenses, the amount you spend will be at a 2.5% loss (only the amount you spend - I do not mean a 2.5% loss on your portfolio) because the bonds will not have time to recover. If you have an individual bond ladder, this will not happen.
Slightly orthogonal question. How reliable is computed duration for TIPS funds anyway, since the cash flows could change ? I assume the formula is the same -- discounted future cash flows ?

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Phineas J. Whoopee
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Re: Do TIPS work? How do we know?

Post by Phineas J. Whoopee » Tue Jan 07, 2020 8:34 pm

abuss368 wrote:
Tue Jan 07, 2020 6:49 pm
Personal inflation can definitely have impact. Inflation can have a larger or smaller impact depending on individual circumstances. This is widely known.
I'm finished with this exchange.

PJW

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Horton
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Re: Do TIPS work? How do we know?

Post by Horton » Tue Jan 07, 2020 8:35 pm

SlowMovingInvestor wrote:
Tue Jan 07, 2020 6:53 pm
typical.investor wrote:
Tue Jan 07, 2020 6:16 pm

I say the TIPS fund may perform worse if you are spending out of it in a rising rate environment. Take Vanguard's Short-Term TIPS fund for instance; it has a duration of 2.5 years. If rates rise 1%, you will have 2.5% in NAV loss. If you are selling to fund expenses, the amount you spend will be at a 2.5% loss (only the amount you spend - I do not mean a 2.5% loss on your portfolio) because the bonds will not have time to recover. If you have an individual bond ladder, this will not happen.
Slightly orthogonal question. How reliable is computed duration for TIPS funds anyway, since the cash flows could change ? I assume the formula is the same -- discounted future cash flows ?
Per Vanguard:
The duration estimates the fund's percentage change in price for a given change in the real interest rates in the TIPS market. Historically, the real interest rates on TIPS have been somewhat less volatile than the nominal yields of conventional US Treasury bonds. However, the relationship varies over time and is difficult to predict. There may be periods when TIPS real yields and prices are more volatile than conventional Treasury bonds.

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Re: Do TIPS work? How do we know?

Post by abuss368 » Tue Jan 07, 2020 8:51 pm

Phineas J. Whoopee wrote:
Tue Jan 07, 2020 8:34 pm
abuss368 wrote:
Tue Jan 07, 2020 6:49 pm
Personal inflation can definitely have impact. Inflation can have a larger or smaller impact depending on individual circumstances. This is widely known.
I'm finished with this exchange.

PJW
Here is an very good article that provides a nice overview of personal inflation from bankrate.com: https://www.bankrate.com/personal-finan ... tion-rate/

Hopefully that helps!

Best.
John C. Bogle - Two Fund Portfolio: Total Stock & Total Bond. "Simplicity is the master key to financial success." || Buy Total Stock until it hurts. Then find a way to buy even more!

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Re: Do TIPS work? How do we know?

Post by Angst » Wed Jan 08, 2020 12:36 pm

abuss368 wrote:
Tue Jan 07, 2020 8:51 pm
Phineas J. Whoopee wrote:
Tue Jan 07, 2020 8:34 pm
abuss368 wrote:
Tue Jan 07, 2020 6:49 pm
Personal inflation can definitely have impact. Inflation can have a larger or smaller impact depending on individual circumstances. This is widely known.
I'm finished with this exchange.

PJW
Here is an very good article that provides a nice overview of personal inflation from bankrate.com: https://www.bankrate.com/personal-finan ... tion-rate/

Hopefully that helps!

Best.

No worries abuss - following a link withing that article you posted it appears that even the US Bureau of Labor Statistics is fairly lenient with the word usage, including an "Individual's Inflation Experience" and a hypothetical "individual's price index".
https://www.bls.gov/cpi/factsheets/aver ... differ.htm

SlowMovingInvestor
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Re: Do TIPS work? How do we know?

Post by SlowMovingInvestor » Wed Jan 08, 2020 1:29 pm

Horton wrote:
Tue Jan 07, 2020 8:35 pm
SlowMovingInvestor wrote:
Tue Jan 07, 2020 6:53 pm

Slightly orthogonal question. How reliable is computed duration for TIPS funds anyway, since the cash flows could change ? I assume the formula is the same -- discounted future cash flows ?
Per Vanguard:
The duration estimates the fund's percentage change in price for a given change in the real interest rates in the TIPS market. Historically, the real interest rates on TIPS have been somewhat less volatile than the nominal yields of conventional US Treasury bonds. However, the relationship varies over time and is difficult to predict. There may be periods when TIPS real yields and prices are more volatile than conventional Treasury bonds.
So one can conclude that the calculated duration of TIPS vs Treasuries (or corporate bonds for that matter) is less likely to be accurate, and that TIPS might fluctuate more than expected from changes in interest rates than the duration would indicate ?

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Horton
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Re: Do TIPS work? How do we know?

Post by Horton » Wed Jan 08, 2020 2:51 pm

SlowMovingInvestor wrote:
Wed Jan 08, 2020 1:29 pm
Horton wrote:
Tue Jan 07, 2020 8:35 pm
SlowMovingInvestor wrote:
Tue Jan 07, 2020 6:53 pm

Slightly orthogonal question. How reliable is computed duration for TIPS funds anyway, since the cash flows could change ? I assume the formula is the same -- discounted future cash flows ?
Per Vanguard:
The duration estimates the fund's percentage change in price for a given change in the real interest rates in the TIPS market. Historically, the real interest rates on TIPS have been somewhat less volatile than the nominal yields of conventional US Treasury bonds. However, the relationship varies over time and is difficult to predict. There may be periods when TIPS real yields and prices are more volatile than conventional Treasury bonds.
So one can conclude that the calculated duration of TIPS vs Treasuries (or corporate bonds for that matter) is less likely to be accurate, and that TIPS might fluctuate more than expected from changes in interest rates than the duration would indicate ?
I don’t think that is the correct conclusion. Basically, the duration estimate should be appropriate if you are looking at changes in real interest rates, but not necessarily nominal rates. You can find real rates here:

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

ana coko
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Re: Do TIPS work? How do we know?

Post by ana coko » Fri Feb 14, 2020 4:12 am

Hello,

I need some help regarding daily calculation of Treasury Inflation Protected Securities. If you buy the bond on OTC market, and the trade confirmation states interest on SD, when do you start with bond amortization? When will you start taking into account market price and index , on TD or SD+1?

thanks

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