TIPS yields

[cyclone6]

I was just looking through some bond listings on E*Trade (after reading Hussman's weekly commentary) - and there are quite a few individual TIPS issues out there with maturities 6 or 7 years out yielding 4%+ real...

If thats the best we can realistically hope to withdraw anyway, isn't now a great time to load up on TIPS and just hold until redemption?

Is there any downside, short of a US bankruptcy?

 

[haha]

I was just looking through some bond listings on E*Trade (after reading Hussman's weekly commentary) - and there are quite a few individual TIPS issues out there with maturities 6 or 7 years out yielding 4%+ real...

If thats the best we can realistically hope to withdraw anyway, isn't now a great time to load up on TIPS and just hold until redemption?

Is there any downside, short of a US bankruptcy?

No downside that I can see, other than giving up the hope of speculative gain either in stocks or in straight treasuries. Some pundits are claiming that 10 year rates will go to 1%. While they may, IMO the potential downside with this is huge.

 

[ziggy29]

I was just looking through some bond listings on E*Trade (after reading Hussman's weekly commentary) - and there are quite a few individual TIPS issues out there with maturities 6 or 7 years out yielding 4%+ real...

If thats the best we can realistically hope to withdraw anyway, isn't now a great time to load up on TIPS and just hold until redemption?

Is there any downside, short of a US bankruptcy?

I don't know about a downside, just a possibility that other choices (i.e. regular Treasuries, federally insured CDs, et cetera) would look better in retrospect.

At these real yields, though, it makes it a lot easier to lock these in now and reduce my equity allocation moving forward. With my fixed income guaranteed to yield a real 3.5% or more, I don't need as much real return (or risk) from equities. That to me is one of the main benefits. I'm relatively comfortable with a conservative 50/50 AA (once stocks are no longer in the toilet) with that kind of guaranteed real return on bonds...

 

[roger r]

I believe the high yield has built into it the risk that we will have some deflation or very low inflation. If we do have deflation, the actual yield will be lower that the real rate. In which case you would have been ahead with plain old FDIC insured CDs. I've actually been looking at TIPS myself, more in the form of a fund. I'd be interested in opinions of some of the experts here, as well.

 

[FIRE'd@51]

Be careful doing your analysis. TIPS inflation adjustments are based upon a 2-month lag, so the December adjustment is based upon October's change in CPI-U, which was negative 1%. This means any existing TIPS you buy today will lose 1% of it's inflation-adjusted principal this month, and this is known today. So those yields are likely to be overstating the real YTM.

If you wait until January's auctions of the 10-year and 20-year TIPS, you can buy them without any inflation-adjustment already built in, so you will not be exposed to this effect if you hold them until maturity.

BTW, Bloomberg is showing the real YTM's on the 5 and 10 year TIPS to be about 2.1% and 2.4%, respectively.

 

[ziggy29]

If you wait until January's auctions of the 10-year and 20-year TIPS, you can buy them without any inflation-adjustment already built in, so you will not be exposed to this effect if you hold them until maturity.

And, of course, the YTM on the newly-issued bonds will be considerably lower to account for the reduced risk factor.

TIPS with more of an inflation adjustment are yielding closer to 3.5% and higher while TIPS issued in 2008 with a very small inflation factor built in are priced to yield closer to 3%.

 

[FIRE'd@51]

TIPS with more of an inflation adjustment are yielding closer to 3.5% and higher while TIPS issued in 2008 with a very small inflation factor built in are priced to yield closer to 3%.

Not according to Bloomberg, and Bloomberg prices the "on-the-run" TIPS.

 

[cyclone6]

I guess its time for a little research. I'm not sure how TIPS work in a deflationary cycle. If you buy a TIPS at auction - and you lock in a 3.5% rate - you are guaranteed that, correct? Even with deflation?

Or do they add a hypothetical -1% inflation rate to pay out only 2.5%?

Even the Vanguard Inflation Protected Bond fund has a current real rate of 3.62%...

 

[lawman]

I'm liking my I-bonds these days paying nearly 9%

 

[FIRE'd@51]

I guess its time for a little research. I'm not sure how TIPS work in a deflationary cycle. If you buy a TIPS at auction - and you lock in a 3.5% rate - you are guaranteed that, correct? Even with deflation?

Or do they add a hypothetical -1% inflation rate to pay out only 2.5%?

If you buy TIPS at auction, you get 100 back at maturity, even if there is deflation, so you will realize at least the stated real YTM, if you hold until maturity.

However, as I understand it, the index ratio can go below 1.0000 in the interim period, so deflation can theoretically cause loss of nominal principal, if you sell the TIPS before maturity.

 

[SteveL]

Institutional - TIPS/CPI Data

This link will take you to a list of all the TIPS issues that have been made. The highest coupon was 4.25% and only one was this high. Most are lower, much lower.

When you buy a TiP from another investor, via a broker, you pay the market price for that bond, usually stated as a number like 95 or 102 etc. that represents that percentage of the face of the bond. In addition you must pay the amount of accumulated inflation represented by the Treasury Index associated with that bond.

Normally, the yield to maturity quoted by the broker does not include future inflation.

Like all bonds, there may be marketability issues in the future, so you should plan to hold them to maturity.

 

[ziggy29]

If you buy TIPS at auction, you get 100 back at maturity, even if there is deflation, so you will realize at least the stated real YTM, if you hold until maturity.

However, as I understand it, the index ratio can go below 1.0000 in the interim period, so deflation can theoretically cause loss of nominal principal, if you sell the TIPS before maturity.

Right -- which is a reminder that when we say TIPS are pretty much a "sure thing" in terms of guaranteeing a certain real return, that assumed buying individual securities and holding to maturity. Selling before maturity (or buying TIPS funds) could yield less overall, or even lose money.

 

[Independent]

Be careful doing your analysis. TIPS inflation adjustments are based upon a 2-month lag, so the December adjustment is based upon October's change in CPI-U, which was negative 1%. This means any existing TIPS you buy today will lose 1% of it's inflation-adjusted principal this month, and this is known today. So those yields are likely to be overstating the real YTM.

If you wait until January's auctions of the 10-year and 20-year TIPS, you can buy them without any inflation-adjustment already built in, so you will not be exposed to this effect if you hold them until maturity.

BTW, Bloomberg is showing the real YTM's on the 5 and 10 year TIPS to be about 2.1% and 2.4%, respectively.

I find this somewhat confusing. This table from the WSJ Treasury Inflation-Protected Securities (TIPS) - Markets Data Center - WSJ.com

purports to have yields for all outstanding TIPS. The two bonds that Bloomberg uses are distinctly below their neighbors. The "5 year" is due 4/15/2013 with a coupon of 5/8 %, and the WSJ has a yield of 2.267% vs. yields over 4% for bonds maturing 6 months earlier or later. I understand the deflation risk with existing bonds, but the numbers look surprisingly large.

Similarly, the "10 year" is due 7/15/2018 and the WSJ has a yield of 2.563%, while the bonds due 6 and 12 months earlier have yields over 3%.

 

[FIRE'd@51]

I find this somewhat confusing. This table from the WSJ Treasury Inflation-Protected Securities (TIPS) - Markets Data Center - WSJ.com

purports to have yields for all outstanding TIPS. The two bonds that Bloomberg uses are distinctly below their neighbors. The "5 year" is due 4/15/2013 with a coupon of 5/8 %, and the WSJ has a yield of 2.267% vs. yields over 4% for bonds maturing 6 months earlier or later. I understand the deflation risk with existing bonds, but the numbers look surprisingly large.

Similarly, the "10 year" is due 7/15/2018 and the WSJ has a yield of 2.563%, while the bonds due 6 and 12 months earlier have yields over 3%.

If you look at the "accrued principal" column in the WSJ table, you will see that the TIPS with yields over 3% have significantly higher accrued principals. The accrued principal divided by 1000 is the index ratio. The most recently issued TIPS, which are the ones quoted on Bloomberg, have significantly lower inflation-adjusted principals (since they have been around for a shorter time). For example, the 1.375% of 7/15/2018 has an accrued principal of 1014 (index ratio = 1.014). This means it has only 1.4% inflation-adjustment built into the maturity value (and it is guaranteed to lose 1% of that this month because of the October decline in CPI-U), so that, after this month, it can only lose 0.4% to deflation if it is held until maturity. If you compare that to the one above it in the table, the 1.625% of 1/15/2018, you can see that it has 4.4% of inflation-adjustment built in, so it has more deflation risk. Presumably, this is why the latter has a higher yield.

 

[FIRE'd@51]

Let me try to quantify my above post a bit, with a "back of the envelope" calculation.

From the WSJ table the price of the 1.625% of 1/15/2018 is 89. Relative to the 1.375% of 7/15/2018, it can lose 3% more to deflation. Since there are 19 interest payments of 0.8125% left, the YTM at a PV of 89 and FV of 100 (according to my HP12C) equals 2.96%. If I raise the PV to 92, I get 2.58%, so there is a potential loss of 38 basis points of one TIPS relative to the other, if both are held until maturity, so the yield difference in the table doesn't look unreasonable to me.

 

[Maurice]

I'm liking my I-bonds these days paying nearly 9%

You dog you, when did you buy? Late 90s?


Mine are paying ~6 and I'm pretty happy about it.

 

[Lsbcal]

In January of this year TIPS went to incredibly low yields. At that time the market was clearly wrong. There were investors then looking in the rear view mirror and buying because the last 12 months had been really good.

Now we have somewhat the opposite situation. It is very unlikely that we will have deflation for an extended period of time. That is why I've bought up to my limit in TIPS.

For those of you who are still confused, I'd take a look at the many posts on the Bogleheads site on TIPS. In particular, see Larry Swedroe's posts.

 

[Dennis]

TIPs vs Other Bond Funds?

Well when I use Lippers Chart on A Per $10k Invested and comparing VIPSX to VFITX, VFIIX? and then for past 10,5,3 yrs?

Very Little reason for me to Own Tips..
And the YTD Rtns on VFITX is Unreal.. + 9% now
While the Tips are Dwn in the Negative column
And seeing as Inflation is not an issue now or in the near future and Deflation is?

They got off to a great start in the last Bear Yrs, but slacked off in 05' & 06', then spiked in 07' and now? In the dumpster.., thus has been pretty volatile for my taste..

I Mybe wrong, but I still can't see much reason to own tips at this time

and For my Short Term $ ( 3 yrs COH for bills ) ? Fido's New Bond Fund> FIBIX..+11% YTD as of 12/1/08' has been my best Bond Fund this yr, so far..

Some have been saying Maybe time to Go back into HYld Corp. ? But not so sure..

BTHOM!

 

[Gearhead Jim]

Me thinks the "volitility" of TIPS exists only of you sell them before maturity, or hold a TIPS fund. If you plan to do either of those things, there are probably better choices.
But if you buy actual TIPS and hold them to maturity, you WILL get the interest along the way, and they WILL be worth AT LEAST face value when they mature; probably more because of inflation.
Stocks and bond funds may or may not perform better over the specific time period, but you can't know what they will be worth on a given date because they have no maturity date.
At least that's the way I understand it, waiting for corrections...

 

[Independent]

If you look at the "accrued principal" column in the WSJ table, you will see that the TIPS with yields over 3% have significantly higher accrued principals. The accrued principal divided by 1000 is the index ratio. The most recently issued TIPS, which are the ones quoted on Bloomberg, have significantly lower inflation-adjusted principals (since they have been around for a shorter time). For example, the 1.375% of 7/15/2018 has an accrued principal of 1014 (index ratio = 1.014). This means it has only 1.4% inflation-adjustment built into the maturity value (and it is guaranteed to lose 1% of that this month because of the October decline in CPI-U), so that, after this month, it can only lose 0.4% to deflation if it is held until maturity. If you compare that to the one above it in the table, the 1.625% of 1/15/2018, you can see that it has 4.4% of inflation-adjustment built in, so it has more deflation risk. Presumably, this is why the latter has a higher yield.

Thanks for the reply. I'm slow replying because I've been trying to do some calculations. I think you are correct in saying that I've under-estimated the importance of the floor. Not having an HP, I set up the cash flows of the bonds on a spreadsheet and calculated IRRs.

If I'm reading everything correctly, the coupons on the two bonds are impacted identically by deflation. If the CPI had an immediate decrease of 3% and stayed there, both bonds would have 3% decreases in coupons from today's levels. The difference is the maturity value, where one bond can drop 1.4% from the Dec 1 value, and the other can drop 4.2%.

I was surprised by how much weight the maturity value gets in the IRR calculation. I'm not accustomed to looking at 9 year bonds with coupons around 1.5%. In these cases the maturity value is a much bigger deal than the coupon. When I calculated IRRs assuming significant deflation, the bond with the 1043 adjusted principal really did lose more value than the bond with the 1014. By my calculation, 5% deflation could cost the 1043 bond 47bp of yield, while the 1014 only loses 20bp.

But, that calculation assumes a 100% probability that we'll have 5% deflation. I'd think that the "most likely" case is still that the CPI in 2018 will be higher than it is in 2008. Today's prices should reflect some weighted average of inflation and deflation scenarios, and the market seems to be weighting the deflation possibility pretty heavily. If I were buying a single bond, I think I'd go against the market and buy the one with the bigger deflation risk. It seems to be paying pretty well for the magnitude of the risk.

 

[samclem]

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.

 

[Gotadimple]

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

 

[Gone4Good]

http://www.econbrowser.com/archives/2008/12/tips_yields.html"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.

 

[samclem]

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 $$.

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?

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. . .

 

[Lsbcal]

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