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Old 12-03-2008, 08:08 PM   #21
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Here's another interesting insight into the machinations of the now-volatile TIPS YTM numbers.

It appears that the Treasury is, as of this week, using a different means to compute the yield of TIPS:

"Starting 12/01/2008, the TIPS yield curve will use on-the-run TIPS as knot points rather than all securities under 20 years."

I'm learning that the jargon of the bond world is very specialized ("knot points"? "on-the-run?" ). Anyway, the upshot (according to the guy at the link above) may be:

"the real interest rate now reported is not a true real interest rate but is infected by the hybrid nature of these bonds. Yields on older off-the-run bonds may be more meaningful."

Getting 3% true yield would be nice, especially as TIPS are very safe and even give you your money back (if held to maturity) in a deflationary environment (of course, this gaurantee only means something if there's net deflation over the entire time you hold the bond--is deflation over a 10 year span really even a remote possibility? Even Japan didn't have it that long) . Of greater concern to me is double-digit inflation, and I think TIPS would shine there, too. Still, I don't buy things I don't understand, and I'm a long way from understanding TIPS ("index ratio?" "inflation factor?"). If just buying a TIPS fund would provide the same hedge against inflation and if there were no concern about future NAV risk when i need to sell, it would be tempting. At this pont, it seems like a lot of complexity. A neophyte n a sea of complexity seldom fares well . . .

Some banks used to offer inflation-linked CD's. It looks like al those banks have gone under. Too bad, as a 10 year 3% plus inflation CD might be an attractive product.
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Old 12-03-2008, 08:39 PM   #22
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Originally Posted by samclem View Post
Here's another interesting insight into the machinations of the now-volatile TIPS YTM numbers.

Still, I don't buy things I don't understand, and I'm a long way from understanding TIPS ("index ratio?" "inflation factor?"). If just buying a TIPS fund would provide the same hedge against inflation and if there were no concern about future NAV risk when i need to sell, it would be tempting.
Samclem,
Do you believe you need an inflation hedge in your overall asset allocation? I understand your concerns about not understanding the investment.

If directly investing is a concern, would you be willing to give up some basis points for an index of TIPS managed by a manager who understands the market? Such as an ETF fund (i.e. TIP OER .20% - market cap weighted index using the Lehman Brothers US Treasury Index, or IPE OER .18% - uses Barclays US Govt Inflation-Linked index) or a passively managed mutual fund (VIPSX OER .20% - dollar weighted average maturity of 7-10 years)?

Granted that if you don't have an account at Vanguard to access their mutual fund, you would have to pay a commission to buy the ETF. But buying management expertise: isn't that why people invest in funds in the first place?

-- Rita
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Old 12-03-2008, 08:52 PM   #23
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"the real interest rate now reported is not a true real interest rate but is infected by the hybrid nature of these bonds. Yields on older off-the-run bonds may be more meaningful."
I think the reverse is true. It looks like Treasury was previously reporting a yield based on an average of all the outstanding securities for a given maturity. Because some of those securities have principal balances that have historic inflation adjustments and some don't, there are a range of 5 year "real" yields depending on which security you buy.

For example, an original issue 10 yr that is 5 years old and a new 5 yr bond will have different yields because the principal balance of the older bond can be revised downward for deflation whereas the new bond can't. They're both 5 yr TIPS but they have different yields. This probably wasn't a problem before because deflation wasn't a concern. But now, the yields on these bonds can be quite different.

To fix that problem, it looks like Treasury is only going to quote "on the run" (recently issued) bonds. This doesn't change the yield investors are getting, which is determined by the market . . . not Treasury.
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Old 12-03-2008, 09:04 PM   #24
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Do you believe you need an inflation hedge in your overall asset allocation?
Almost my entire portfolio is in stock MFs, and I'm fine with that for the most part. But, when I see 3% real yield to maturity (and that's what individual TIPS have been offering in the recent past) it gets my interest. For example, I could put a chunk of money in those (inside my solo 401k) and pick a maturity coinciding with my 59 1/2 "birthday." The mature bonds (plus reinvested coupon payments) could help cover the years between 60 and 67 (when I just might get a little social security check or two). Or, if inflation goes to 10+ percent in 5 or six years (as the government starts printing money to pay their bills), I'd expect these bonds to appreciate rapidly and I could sell a few. That kind of thinking is speculation, totally against the efficient market theory, and probably a result of testosterone poisoning--but there it is. With YTM of TIPS at historic levels and my belief that the risk of inflation may be underappreciated by the market, I'm thinking about throwing the dice. Still, I realize I don't know anything about this biz and am ripe for a mis-step that will cost big $$.


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If directly investing is a concern, would you be willing to give up some basis points for an index of TIPS managed by a manager who understands the market?
I'd give up the ER just to be rid of the complexity of buying the individual TIPS issues. But, as far as I have been able to tell, buying an ETF or MF gives up the gauranteed value of the TIP at maturity. If I want that gauranteed chunk-o-change, I have to buy the individual issues.

How will a TIP fund with a 10 year avg maturity react in a high inflation environment? Would it react the same as the share price of an individual TIP with the same maturity?

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Granted that if you don't have an account at Vanguard to access their mutual fund, you would have to pay a commission to buy the ETF. But buying management expertise: isn't that why people invest in funds in the first place?
I could buy the Vanguard TIP MF (VIPSX) in my account there, or buy the individual TIPS in the secondary market online free of cost (except fro bid/ask spread) in my Fidelity solo401K. Management expertise--I don't much believe in it in my equity funds (almost everything is in index funds). Maybe things are different int he bond world. Yet another thing I don't know. Maybe I should just stay out of the pool and let the adults play. . .
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Old 12-03-2008, 10:41 PM   #25
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A lot of those 3% yields not available now. This Fidelity listing shows they are now history if you want to go out beyond 8 years: Offerings
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Old 12-03-2008, 11:01 PM   #26
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Yep. They were up there before, maybe they'll come back. And when they do, I still won't understand how they work, and I still won't buy them. Compared to TIPS, explaining and understanding the blue lines in hockey is a piece of cake.

For anyone interested, here's a good explanation of the whys/hows of TIPS during deflationary periods.
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Old 12-03-2008, 11:10 PM   #27
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Well you can still buy a 2.98% 8yr TIPS. If you hold for 8 years you will get 2.98% real return. Seems pretty easy to understand to me. OK, there are a few issues that confuse people but if you hold to maturity then it is not so difficult. Personally I may well sell some before then if yields come down a lot. Would then probably move to short term treasuries until real rates go back up.

But I don't know anything about those blue hockey lines .
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Old 12-04-2008, 08:25 AM   #28
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I think the reverse is true.
I think what Greg Mankiw is saying is that the older (off-the-run) TIPS may be more meaningful in obtaining the market's expectation for inflation/deflation, due to the hybrid nature of TIPS. When you buy a TIPS you are buying a pure CPI-linked security with an embedded put which guarantees you will receive 100 in today's $ at maturity, even if you experience net deflation over the life of the TIPS. The older TIPS with a significant accrued principal will behave in a more symmetric fashion should net deflation occur over the time between when you purchase the TIPS in the secondary market and its maturity. The higher the accrued principal, the less the value of the embedded put (it is more out-of-the-money), and the more closely the TIPS will behave like a pure CPI-linked security. By pure CPI-linked security, I mean one that will perfectly track the CPI at maturity, both with inflation and with deflation, so that you could receive less than 100 in today's $ at maturity.

If you buy TIPS at auction, the index ratio is unity, so the put is at-the-money and has more value, hence the lower real yield (part of what you are paying for the TIPS goes to pay for the put). To correctly deduce the market's expectation for inflation/deflation, one would have to calculate the value of this put. Since this calculation is difficult, he is suggesting using a TIPS with a large accrued principal, in which the put has negligible value.
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Old 12-04-2008, 08:43 AM   #29
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A lot of those 3% yields not available now. This Fidelity listing shows they are now history if you want to go out beyond 8 years
Last week I bought $25K face in TIPS maturing in January 2025. The latest quote I saw for these bonds was about 7% higher than my purchase price. I think that takes their YTM down from about 3.4% (where I bought them) to around 2.8%, maybe slightly less.
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