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Help with "hybrid bond" in my portfolio (30-yr yield with 1-year duration!)
Old 02-20-2013, 06:03 PM   #1
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Help with "hybrid bond" in my portfolio (30-yr yield with 1-year duration!)

This is my first post and I've tried my best to post according to the rules, but I apologize in advance if I've made any mistakes!

I have a fascinating "hybrid bond" in my portfolio and I'm having trouble determining how to think about it, particularly with respect to the inflation protection it may provide.

Basically, it works like this:
-Long ago, my employer converted my defined benefit pension plan to a cash balance (yes, it sucks, I know, but that's a different conversation)
-This cash balance receives an employer contribution each month at a fixed rate
-In addition - and here is the interesting part - the cash balance earns a rate of interest every month equal to the average yield on the longest term Treasury Bond over the 24-month period preceding the last June 30th.

So basically, I have a "hybrid bond" that has the yield of the 30-year Treasury Bond with the duration of a ~1-year Treasury Bill. Granted, there is a slight lag in the yield, but the maximum "maturity" on this is 24 months.

So, my question is - does this provide me with inflation protection? If so, is this better than TIPS or worse?

My understanding is that real yields on the 30-year Treasury bond are nearly always positive, so my opinion is that the answer is yes, but I'm not sure if it's better than holding TIPS.

Thanks, everyone! I appreciate your input.
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Old 02-20-2013, 06:18 PM   #2
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I suppose a better title for this would have been "Is my money protected against inflation?"
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Old 02-20-2013, 06:23 PM   #3
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I have something similar. You have a savings account with a high interest rate.
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Old 02-20-2013, 07:04 PM   #4
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I have something similar. You have a savings account with a high interest rate.
Yes, that's true, but I'm still left wondering whether this provides inflation protection.

Could it be considered a substitute for TIPS in my portfolio?
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Old 02-20-2013, 07:50 PM   #5
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Yes, that's true, but I'm still left wondering whether this provides inflation protection.

Could it be considered a substitute for TIPS in my portfolio?
Not a direct one, but it seems unlikely the 30 year would yield leess than inflation on a 24 month rolling reset yield basis.
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Old 02-20-2013, 08:10 PM   #6
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.
So, my question is - does this provide me with inflation protection? If so, is this better than TIPS or worse?
In tody's interest rate environment, your hybrid bond certainly beats TIPS of equal duration. 1-2 year TIPS currently have a real yield of about negative 2% . If you were to purchase 30-year TIPS (which currently have a duration of about 27 with respect to changes in real interest rates), you would only lock in a real return of about 0.6% to maturity, so I think your hybrid bond will very likely do better than that, with much less interim risk.
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Old 02-20-2013, 11:06 PM   #7
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...So, my question is - does this provide me with inflation protection?...
Yes. in theory the build up of a the interest rate would begin with expected inflation and then add on premiums for liquidity risk, credit risk (minimal with a Treasury bond), etc. so in theory the interest rate should always exceed the inflation rate (or at least the expected inflation rate).
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Old 02-21-2013, 11:04 AM   #8
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In tody's interest rate environment, your hybrid bond certainly beats TIPS of equal duration. 1-2 year TIPS currently have a real yield of about negative 2% . If you were to purchase 30-year TIPS (which currently have a duration of about 27 with respect to changes in real interest rates), you would only lock in a real return of about 0.6% to maturity, so I think your hybrid bond will very likely do better than that, with much less interim risk.
I think your line of thinking is correct - in order to compare the two, I need to compare the real yield on TIPS to the real yield on the 30-year (nominal yield less inflation rate for the same period).

My guess is that you're also correct in saying that my cash balance plan will offer superior inflation protection when compared to TIPS. So the implication is that I can reduce the TIPS allocation in my portfolio.

Thanks!
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