US TIPS as an European Investor

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Topic Author
DollarvsGold
Posts: 24
Joined: Sun Aug 09, 2020 11:47 am

US TIPS as an European Investor

Post by DollarvsGold »

Hi!

I'm from Europe and look for exposure to the US dollar (so I don't want currency hedging). I figured out to invest in TIPS (for example TIP ETF) is one of the safest ways to do that, because if the dollar rises against the euro, I would profit (normally), but I noticed in a falling dollar environment TIPS tend to do well (because rising inflation in the US often weakens the dollar but is good for TIPS).

I backtested TIPS via portfoliovisualizer and compared it with the Dollar Index. When the dollar had a bad year, TIPS usually performed well:

2002 TIPS +16,61% Dollar Index -9,3%
2003 TIPS +8% Dollar -15,33%
2004 TIPS +8,27% Dollar -6,36%
2006 TIPS +0,28% Dollar -5,26%
2007 TIPS +11,92% Dollar -9,97%
2009 TIPS +8,94% Dollar -6,85%
2017 TIPS +2,92% Dollar -8,62%

Average in bad years for the dollar: TIPS +8,13% Dollar -8,81%

TIP ETF had one significant down year: 2013 TIPS -8,5% Dollar +3,5%

Link portfoliovisualizer:
https://www.portfoliovisualizer.com/bac ... ion3_2=100


So it's a investment in the dollar with a "hedge" against a weak dollar! Does that make sense? Am I missing something here?
Valuethinker
Posts: 41439
Joined: Fri May 11, 2007 11:07 am

Re: US TIPS as an European Investor

Post by Valuethinker »

DollarvsGold wrote: Mon Aug 10, 2020 11:04 am Hi!

I'm from Europe and look for exposure to the US dollar (so I don't want currency hedging). I figured out to invest in TIPS (for example TIP ETF) is one of the safest ways to do that, because if the dollar rises against the euro, I would profit (normally), but I noticed in a falling dollar environment TIPS tend to do well (because rising inflation in the US often weakens the dollar but is good for TIPS).

I backtested TIPS via portfoliovisualizer and compared it with the Dollar Index. When the dollar had a bad year, TIPS usually performed well:

2002 TIPS +16,61% Dollar Index -9,3%
2003 TIPS +8% Dollar -15,33%
2004 TIPS +8,27% Dollar -6,36%
2006 TIPS +0,28% Dollar -5,26%
2007 TIPS +11,92% Dollar -9,97%
2009 TIPS +8,94% Dollar -6,85%
2017 TIPS +2,92% Dollar -8,62%

Average in bad years for the dollar: TIPS +8,13% Dollar -8,81%

TIP ETF had one significant down year: 2013 TIPS -8,5% Dollar +3,5%

Link portfoliovisualizer:
https://www.portfoliovisualizer.com/bac ... ion3_2=100


So it's a investment in the dollar with a "hedge" against a weak dollar! Does that make sense? Am I missing something here?
The usual problem in econometrics is that the dependent and the independent variable are both correlated with some other, 3rd, variable that we have not modelled. Or 2 of the explanatory (independent) variables are in fact correlated.

One could run the time series back to the first TIPS bonds (1998?) but I am not sure what it would tell you.

There's a logic here - that the market thinks a weaker US dollar leads to higher inflation, so it switches some of its assets to a real return asset (TIPS) to preserve its value.

But I don't think of it as reliable enough relationship, or strong enough a one, to count on.

David Swensen's book on Personal Investing will take you through why, as in investor, you do not want to protect yourself against inflation in other currencies. That said, we both know the problems with Eurozone ILBs - the concentration on Italy, the weakest major credit in the Eurozone.

If you are prepared to wear the currency risk, TIPS are not a bad alternative - on the theory that USD inflation eventually becomes world inflation. However the currency volatility will be much greater than the bond volatility - you are in essence taking a risk on the USD exchange rate with your home currency.

So in theory a US TIPS fund, hedged back to your home currency, would be ideal. Expected returns would be quite low, though.

Is there a global govt ILB index fund? You'd have more credit risk (probably) than the US, but if this fund hedged back into your home currency then you get rid of the currency risk.
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#Cruncher
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Re: US TIPS as an European Investor

Post by #Cruncher »

DollarvsGold wrote: Mon Aug 10, 2020 11:04 amI'm from Europe and look for exposure to the US dollar ... I backtested TIPS via portfoliovisualizer and compared it with the Dollar Index. When the dollar had a bad year, TIPS usually performed well ... So it's a investment in the dollar with a "hedge" against a weak dollar! Does that make sense? Am I missing something here?
Why do you want exposure to the US dollar? Is it to protect against your own currency depreciating in value? If so, wouldn't it be better to invest in a government bond that is indexed to your own country's consumer price index?

I wouldn't conclude much from the fact that that the TIP ETF tends to gain in years when the dollar index falls. The ETF goes up most years so it's natural that it will mostly go up when the dollar index goes down. The same thing happens with Vanguard's Total Bond Market fund, a fund that invests only in non-inflation-indexed bonds. (See Portfolio Visualizer with VBTLX added.)

Buying individual TIPS or a TIPS fund isn't really in investment in the US dollar. You're really buying the purchasing power of a United States resident. For example, say it would cost $100,000 for you to live a year in the US. If you bought $100,000 of 10-year TIPS [*], you'd be assuring yourself that, regardless of US inflation, in theory you'd have enough dollars to live the same way for a year in the US ten years from now. But if you want "exposure to the US dollar", you should avoid TIPS and instead buy regular, non-inflation-indexed, US Treasury bonds or a fund that invests in them.

* Since 10-year TIPS currently have a negative yield of about -1.0% (see here), this would cost about $110,000 (100000 / 0.99 ^ 10).
Topic Author
DollarvsGold
Posts: 24
Joined: Sun Aug 09, 2020 11:47 am

Re: US TIPS as an European Investor

Post by DollarvsGold »

Valuethinker wrote: Tue Aug 11, 2020 7:20 am
The usual problem in econometrics is that the dependent and the independent variable are both correlated with some other, 3rd, variable that we have not modelled. Or 2 of the explanatory (independent) variables are in fact correlated.

One could run the time series back to the first TIPS bonds (1998?) but I am not sure what it would tell you.

There's a logic here - that the market thinks a weaker US dollar leads to higher inflation, so it switches some of its assets to a real return asset (TIPS) to preserve its value.

But I don't think of it as reliable enough relationship, or strong enough a one, to count on.

David Swensen's book on Personal Investing will take you through why, as in investor, you do not want to protect yourself against inflation in other currencies. That said, we both know the problems with Eurozone ILBs - the concentration on Italy, the weakest major credit in the Eurozone.

If you are prepared to wear the currency risk, TIPS are not a bad alternative - on the theory that USD inflation eventually becomes world inflation. However the currency volatility will be much greater than the bond volatility - you are in essence taking a risk on the USD exchange rate with your home currency.

So in theory a US TIPS fund, hedged back to your home currency, would be ideal. Expected returns would be quite low, though.

Is there a global govt ILB index fund? You'd have more credit risk (probably) than the US, but if this fund hedged back into your home currency then you get rid of the currency risk.
Thank you for your detailed answer!
I seek exposure to the dollar, so currency risk is ok to me. I want to profit if the dollar gains in value. I figured TIPS are a better way to do that than nominal US bonds, because the risk of a weakening dollar becomes smaller due to the nature of TIPS, they would profit more in a weak dollar environment/inflation in the US in my estimation.
Topic Author
DollarvsGold
Posts: 24
Joined: Sun Aug 09, 2020 11:47 am

Re: US TIPS as an European Investor

Post by DollarvsGold »

#Cruncher wrote: Tue Aug 11, 2020 8:05 am
DollarvsGold wrote: Mon Aug 10, 2020 11:04 amI'm from Europe and look for exposure to the US dollar ... I backtested TIPS via portfoliovisualizer and compared it with the Dollar Index. When the dollar had a bad year, TIPS usually performed well ... So it's a investment in the dollar with a "hedge" against a weak dollar! Does that make sense? Am I missing something here?
Why do you want exposure to the US dollar? Is it to protect against your own currency depreciating in value? If so, wouldn't it be better to invest in a government bond that is indexed to your own country's consumer price index?

I wouldn't conclude much from the fact that that the TIP ETF tends to gain in years when the dollar index falls. The ETF goes up most years so it's natural that it will mostly go up when the dollar index goes down. The same thing happens with Vanguard's Total Bond Market fund, a fund that invests only in non-inflation-indexed bonds. (See Portfolio Visualizer with VBTLX added.)

Buying individual TIPS or a TIPS fund isn't really in investment in the US dollar. You're really buying the purchasing power of a United States resident. For example, say it would cost $100,000 for you to live a year in the US. If you bought $100,000 of 10-year TIPS [*], you'd be assuring yourself that, regardless of US inflation, in theory you'd have enough dollars to live the same way for a year in the US ten years from now. But if you want "exposure to the US dollar", you should avoid TIPS and instead buy regular, non-inflation-indexed, US Treasury bonds or a fund that invests in them.

* Since 10-year TIPS currently have a negative yield of about -1.0% (see here), this would cost about $110,000 (100000 / 0.99 ^ 10).
Thanks. Even though Total Bonds and TIP had a similar return over that time period, in the weak dollar years TIP did better on average. That could be a coincidence of course, but I think this could be because rising inflation in the US leads to a weaker dollar in general, according to my knowledge.
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