How risky is interest rate risk in TIPS ladders longer than 30 years?

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IDpilot
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Re: How risky is interest rate risk in TIPS ladders longer than 30 years?

Post by IDpilot »

StillGoing wrote: Sat Jun 29, 2024 3:48 am Thank you for the recent comments. I was wrong in one assumption (about US treasury markets) and consequently wrong in my conclusions.

1) The (non)existence of stripped TIPS. Since https://www.treasurydirect.gov/marketab ... es/strips/, states "Treasury securities with a fixed-principal, such as notes, bonds, and TIPS are eligible and may be stripped." and Zwecher's book (Retirement Portfolios) incorporates them (in either coupon or principal form) I assumed that stripped TIPS were available to retail customers. This was my first mistake! Does anyone know why they are not available?

2) My second mistake, was then assuming that a ladder consisting of zero coupon TIPS was actionable (which, obviously it isn't if they are not available).

FWIW, I've redone my calculations assuming reinvested coupons and found that a 2 percentage point drop in total returns from 2.135% to 0.135% (with coupons of 2.124% and 0.135%) at the start of Year 1, means that the 35th rung is reduced to providing just under 1% income compared to over 3% income for the zero coupon version. In other words, I agree that the interest rate sensitivity of the extended ladder income is larger with coupons than without.

cheers
StillGoing
Notes or bonds may be ‘‘stripped’’—divided into separate principal and interest components. These components must be maintained in the commercial book-entry system. Stripping is done at the option of the holder, and may occur at any time from issuance until maturity. -31 CFR Part 356.31

The short answer is because no holder of TIPS has chosen to create any STRIPS. Why? I don't have a clue.
Wrench
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Re: How risky is interest rate risk in TIPS ladders longer than 30 years?

Post by Wrench »

StillGoing wrote: Sat Jun 29, 2024 3:48 am <SNIP>
Does anyone know why they are not available?

Probably the same reason inflation adjusted annuities in the U.S. are not available - demand/interest is low. When TIPS rates are negative why would anyone want to buy one? Even when rates are positive but only slightly above zero, the bond is essentially very close to a STRIP. Again, why would anyone go to the trouble to create a STRIP? It is only recently that coupon rates are higher so maybe soon someone will create TIPS STRIPS. But I am not optimistic as I suspect that those who would are waiting to see if higher coupon rates persist.

Wrench
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StillGoing
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Re: How risky is interest rate risk in TIPS ladders longer than 30 years?

Post by StillGoing »

IDpilot wrote: Sat Jun 29, 2024 7:02 am
StillGoing wrote: Sat Jun 29, 2024 3:48 am Thank you for the recent comments. I was wrong in one assumption (about US treasury markets) and consequently wrong in my conclusions.

1) The (non)existence of stripped TIPS. Since https://www.treasurydirect.gov/marketab ... es/strips/, states "Treasury securities with a fixed-principal, such as notes, bonds, and TIPS are eligible and may be stripped." and Zwecher's book (Retirement Portfolios) incorporates them (in either coupon or principal form) I assumed that stripped TIPS were available to retail customers. This was my first mistake! Does anyone know why they are not available?

2) My second mistake, was then assuming that a ladder consisting of zero coupon TIPS was actionable (which, obviously it isn't if they are not available).

FWIW, I've redone my calculations assuming reinvested coupons and found that a 2 percentage point drop in total returns from 2.135% to 0.135% (with coupons of 2.124% and 0.135%) at the start of Year 1, means that the 35th rung is reduced to providing just under 1% income compared to over 3% income for the zero coupon version. In other words, I agree that the interest rate sensitivity of the extended ladder income is larger with coupons than without.

cheers
StillGoing
Notes or bonds may be ‘‘stripped’’—divided into separate principal and interest components. These components must be maintained in the commercial book-entry system. Stripping is done at the option of the holder, and may occur at any time from issuance until maturity. -31 CFR Part 356.31

The short answer is because no holder of TIPS has chosen to create any STRIPS. Why? I don't have a clue.
I wonder whether the retail customer is the 'holder' in this context. If so, then one could divide a 30 year TIPS used to extend the ladder, retain the principal part and sell the interest components. There will be direct costs (there will be commissions on selling 60 individual coupons for a 30 year TIPS) and indirect ones (bid-ask spread) that may make this an expensive option.

cheers
StillGoing
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Kevin M
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Re: How risky is interest rate risk in TIPS ladders longer than 30 years?

Post by Kevin M »

Wrench wrote: Sat Jun 29, 2024 8:07 am When TIPS rates are negative why would anyone want to buy one? Even when rates are positive but only slightly above zero, the bond is essentially very close to a STRIP. Again, why would anyone go to the trouble to create a STRIP? It is only recently that coupon rates are higher so maybe soon someone will create TIPS STRIPS. But I am not optimistic as I suspect that those who would are waiting to see if higher coupon rates persist.

Wrench
The underlined statement is false. Here is the history of TIPS coupons for 20y and 30y maturities:

Image

This got me wondering about how long STRIPS have been available, and I found this web page at TD: Timeline of Separate Trading of Registered Interest and Principal Securities (STRIPS) — TreasuryDirect. Here's a relevant excerpt:
Year: 1985

Event: The STRIPS program was initiated for new Treasury securities that mature in 10 years or over and are maintained in the Federal Reserve book-entry system. The Treasury had vacated its objections to stripping after the tax law was changed in 1982 to include the accretion of discount on Treasury securities in current income, using a compound interest formula. The market can trade separate principal and interest components, each of which is a zero-coupon instrument, in book-entry form as direct obligations of the United States.
So the STRIPS program has been available since before the first TIPS was issued in 1997.

As to why there are no stripped TIPS, it could be that they're too complicated for the average investor to understand. I've heard more than one tale of brokers discouraging their clients from buying TIPS because the yields are so low, indicating that they don't really understand real yields.
If I make a calculation error, #Cruncher probably will let me know.
JackoC
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Re: How risky is interest rate risk in TIPS ladders longer than 30 years?

Post by JackoC »

Wrench wrote: Sat Jun 29, 2024 8:07 am
StillGoing wrote: Sat Jun 29, 2024 3:48 am <SNIP>
Does anyone know why they are not available?

Probably the same reason inflation adjusted annuities in the U.S. are not available - demand/interest is low. When TIPS rates are negative why would anyone want to buy one? Even when rates are positive but only slightly above zero, the bond is essentially very close to a STRIP. Again, why would anyone go to the trouble to create a STRIP? It is only recently that coupon rates are higher so maybe soon someone will create TIPS STRIPS. But I am not optimistic as I suspect that those who would are waiting to see if higher coupon rates persist.
I agree same general reason, lack of interest, but a better reason for that lack of interest in case of TIPS STRIPS than lack of CPI adjusted SPIA's. The latter is a significant hole in the market. There is a basic dilemma between TIPS hedging inflation risk but offering zero longevity risk hedging, and SPIA's hedge longevity risk hedging with no inflation risk hedging (a preprogrammed step up in annuity amount likewise does not hedge inflation risk whatsoever). It's indicative of how the retail side of financial markets cannot be assumed efficient, presumed efficient outcomes are only those where professional interest is brought to bear. A retail product will not exist if the retail market doesn't demand it (at what would be the efficient price), even if there's a very good financial theory reason it should exist.

OTOH you have to be pretty picky about the 'perfect ladder' to care much about coupon v zero coupon TIPS IMO. Especially as you say with a recent inventory of seasoned TIPS with coupons near zero. Though if zero coupon TIPS existed at competitive prices, I'd find them slightly preferable.
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