Why I sold our TIPS fund

[njhowie]

We had about 10% of DW's 401k in VAIPX. It's done well over the past year and since the March selloff. Shares (NAV) are currently at 7 year highs.

However, what bothers me is that SEC yield is now negative 1% - so return is entirely based on inflation (expectations).

https://advisors.vanguard.com/inves...tion-protected-securities-fund-admiral-shares

 

[sengsational]

That fund holds AAA bonds, not TIPS.

 

[njhowie]

What it says:

Invests primarily in Treasury inflation-protected securities.

HOLDINGS % OF FUNDS MARKET VALUE FACE AMOUNT COUPON MATURITY DATE
TREASURY (CPI) NOTE 9.46% $2,764,456,344.84 $2,655,200,000.00 0.13% 04/15/2025
TREASURY (CPI) NOTE 3.72% $1,087,440,016.70 $947,936,100.00 0.38% 07/15/2023
TREASURY (CPI) NOTE 3.69% $1,077,803,105.39 $931,255,900.00 0.63% 01/15/2024
TREASURY (CPI) NOTE 3.68% $1,075,723,094.25 $953,771,400.00 0.13% 07/15/2024
TREASURY (CPI) NOTE 3.53% $1,030,389,934.08 $960,000,000.00 0.63% 04/15/2023
TREASURY (CPI) NOTE 3.49% $1,020,699,539.89 $897,330,200.00 0.13% 01/15/2023
TREASURY (CPI) NOTE 3.49% $1,020,024,422.06 $895,300,000.00 0.25% 01/15/2025
TREASURY (CPI) NOTE 3.24% $947,775,840.30 $820,844,000.00 0.38% 07/15/2025
TREASURY (CPI) NOTE 3.24% $946,839,751.02 $879,000,000.00 0.13% 01/15/2030
TREASURY (CPI) NOTE 3.09% $903,861,035.19 $792,019,400.00 0.13% 07/15/2022

 

[sengsational]

Ah, I stand corrected. I looked at what it said in Yahoo finance (Morningstar). It had 0% government.

 

[OldShooter]

We had about 10% of DW's 401k in VAIPX. It's done well over the past year and since the March selloff. Shares (NAV) are currently at 7 year highs.

However, what bothers me is that SEC yield is now negative 1% - so return is entirely based on inflation (expectations).

https://advisors.vanguard.com/inves...tion-protected-securities-fund-admiral-shares

Interesting. I think this is a fairly conventional approach; TIPS simply as an investment option, judged primarily based on short term considerations.

Our view is quite different. First, we buy bonds, not funds, so we don't care much about interest rate changes between purchase date and maturity.

Second, and I'm sure this is really rare, we believe that with TIPS the rule has to be: "Go big or go home." If one doesn't buy enough TIPS to protect a serious amount of money, why buy any at all? One good Taleb quotation is: "Don't tell me what you think. Tell me what is in your portfolio." Skin in the game IOW. The fixed income portion of our 75/25 AA is 90% in TIPS and that is probably more money than we will ever need.

 

[jazz4cash]

I was thinking of starting a position in TIPS but I was stuck on how much I needed to be worthwhile. I don’t think I’d go above15%.

 

[Sunset]

Interesting. I think this is a fairly conventional approach; TIPS simply as an investment option, judged primarily based on short term considerations.

Our view is quite different. First, we buy bonds, not funds, so we don't care much about interest rate changes between purchase date and maturity.

Second, and I'm sure this is really rare, we believe that with TIPS the rule has to be: "Go big or go home." If one doesn't buy enough TIPS to protect a serious amount of money, why buy any at all? One good Taleb quotation is: "Don't tell me what you think. Tell me what is in your portfolio." Skin in the game IOW. The fixed income portion of our 75/25 AA is 90% in TIPS and that is probably more money than we will ever need.

I have read a number of times how you think TIPs are good (if we ever get inflation), and I know very little about them.

Has TIPS changed regarding interest, ?
I'm thinking you bought all your TIPs a long time ago, say 10 yrs. (just a guess) when they paid what we now consider high rates.
Would you buy TIPs now considering they are low to negative interest rates ?

Maybe it does not matter when you buy TIPs as the rate possibly resets every 6 months, is that true ?

 

[njhowie]

30-Year TIPS Reopening Gets First Negative Real Yield In History

https://seekingalpha.com/article/43...ing-gets-first-negative-real-yield-in-history

 

[njhowie]

Maybe it does not matter when you buy TIPs as the rate possibly resets every 6 months, is that true ?

Coupon rate never resets. As with any bond, you are paid the coupon rate every 6 months. Inflation adjustment is updated monthly and accumulates, which gets paid at maturity.

https://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm

 

[OldShooter]

I have read a number of times how you think TIPs are good (if we ever get inflation), and I know very little about them. ...

Well our view is the same view we have about fire insurance. We buy fire insurance on our houses because we do not want to bear the cost of a major fire ourselves. The fact that we have fire insurance does not make us want to have a fire however. We are quite happy to find our insurance premiums "wasted" because we have never had a house fire.

We view TIPS the same way. Compared to a straight government bond, TIPS pay less. That differential is the premium we pay for the inflation insurance they provide. Again, that does not make us wish for inflation and we are happy to see our inflation insurance premium "wasted." Inflation like we saw around 1980 would be far more devastating to us than a house fire would be.

I'm thinking you bought all your TIPs a long time ago, say 10 yrs. (just a guess) when they paid what we now consider high rates. Would you buy TIPs now considering they are low to negative interest rates ?...

We bought very serious six figures in 2006/7, the 2s of 2026. So yes, a higher interest rate environment. But it really doesn't matter when viewing the TIPS vs Treasury rate differential as an insurance premium. The premium cost is always there and one has the option of paying it, buying TIPS, or not, buying govvies.

Maybe it does not matter when you buy TIPs as the rate possibly resets every 6 months, is that true ?

Coupon rate never resets. As with any bond, you are paid the coupon rate every 6 months. Inflation adjustment is updated monthly and accumulates, which gets paid at maturity. ...

Close but not quite. Minor Error: Inflation adjustments to the principal value of the TIPS are made twice a year, not monthly.

Major: The interest payments are made on the current value of the TIPS, not the original face value. So to say the coupon rate does not change can lead to serious misunderstandings. Just for grins, say I have a $100K bond with a coupon of 1%. With an ordinary govvie this would man that I'll get a $500 check twice a year and my depreciated $100K back at maturity. With a TIPS I may never get a $500 check. It's likely they will all be bigger. Six months into the bond, for example, if there has been 1% inflation, the face value will be adjusted to $101K and the coupon rate applied, resulting in a check for $505. If this is a 30 year bond and inflation runs at 2.3% its face value will have doubled at maturity, $200K, and that last 6-month interest check will be $1K.

So yes, you could say that the rate resets every six months if you are dividing the interest check value by the original face value of the TIPS.

Any time you see a YTM number for a TIPS, it is almost certain to be a lower bound -- implicitly assuming zero inflation. The Seeking Alpha guy does not understand this. (IMO the Seeking Alpha "crowd sourced" columns are usually worthless and almost always transparent marketing efforts by the authors. I do not read anything there.)

Long answer, sorry.

 

[Sunset]

Well our view is the same view we have about fire insurance. ...

We view TIPS the same way. Compared to a straight government bond, TIPS pay less. That differential is the premium we pay for the inflation insurance they provide....

We bought very serious six figures in 2006/7, the 2s of 2026. So yes, a higher interest rate environment. But it really doesn't matter when viewing the TIPS vs Treasury rate differential as an insurance premium. The premium cost is always there and one has the option of paying it, buying TIPS, or not, buying govvies.

....

Thanks for the explanation of the inflation factor in TIPs.

I looked up Treasury rates back in 2006, didn't really see TIPs, but just for an approximation I see rates for 10 or 20 yr bonds were around 4.6% (very approx).
If I had bought some, I'd feel quite good about them paying 4.6% on the inflated value of the bond.

But I look at them today, and they pay much lower, approx .5 to 1%.

That is where I have concern, because just like in 2006 companies pay a dividend close to 2% (example VTI) so the relative reward of the TIP has dropped.
I wonder what happens in 3 yrs if interest rates go up to 4% because inflation is 3.5%, My new TIP would pay 1% on a 3.5% increased value so that is good, but surely someone could buy a new TIP paying 3% , so my TIP would have less market value, unless I held it to maturity.

Are these valid concerns to have about TIP's:

1. That they are now relatively more expensive than in the past ?
2. And face a marketplace disadvantage in a rising rate environment similar to regular bonds ?

 

[kevink]

There's an excellent series of short pieces on TIPS at this site:

https://movement.capital/history-of-tips-and-how-tips-bonds-work/

The link is to the first post in the series; the other parts are linked at the bottom.

And highly-regarded personal finance writer Jonathan Clements wrote in a recent post of his decision to put his entire bond allocation in short-term Treasuries and TIPS:

https://humbledollar.com/2020/07/my-four-goals/?utm_source=mailpoet&utm_medium=email&utm_campaign=another-ses-test_7

His reasons for his decision are very much in line with the recent Bridgewater paper on bonds in a zero interest rate environment. I find them compelling and am sticking with short-duration Treasuries and TIPs for the foreseeable future.

 

[OldShooter]

@Sunset, I just don't look at TIPS the way you do, strictly as investments. But pretty much anything that you say about TIPS can also be said about straight treasuries. The only difference between TIPS and treasuries is the yield reduction I attribute to the inflation insurance value.

Are these valid concerns to have about TIP's:

1. That they are now relatively more expensive than in the past ?
2. And face a marketplace disadvantage in a rising rate environment similar to regular bonds ?

I suppose. It's exactly the same as for regular treasuries though. In most respects, TIPS are "regular bonds" and behave that way. You are overthinking this IMO.

... I looked up Treasury rates back in 2006, didn't really see TIPs, but just for an approximation I see rates for 10 or 20 yr bonds were around 4.6% (very approx). If I had bought some, I'd feel quite good about them paying 4.6% on the inflated value of the bond.

Yup, me too. But a regular govvie does not adjust for inflation or pay based on inflation. TIPS nominal yields back then were obviously lower, but due to flawed YTM calculations, not as low as they looked.

 

[OldShooter]

There's an excellent series of short pieces on TIPS at this site: https://movement.capital/history-of-tips-and-how-tips-bonds-work/ ...

Confirmation bias, of course, but I like the article. He very elegantly states the exact reason that I buy TIPS as inflation insurance:

"TIPS offer unlimited potential outperformance over Treasuries in inflationary environments, while regular Treasuries only offer limited potential outperformance over TIPS in deflationary environments. " (italics his)
​

I haven't mentioned it but I have no fear at all that we will see a seriously deflationary environment in the US. (Not interested in debating it, though.)

The article also says:

"An investor that only allocates to regular bonds is vulnerable to higher than expected inflation, yet solely using TIPS would result in underperformance if future inflation is less than expected."

​

The difference that what he is calling "underperformance" is what I call my "inflation insurance premium." As I said, I am happy to risk paying it.

 

[kevink]

What OldShooter said!

A Short (1-5 year - e.g. VTIP) TIPS/Short Term Treasury barbell is agnostic about inflation and (IMHO) probably about as bullet-proof a place to park cash as ballast for your equities (which as Jonathan Clements says is all bonds are good for at this point, since their real yield is negative across the board).

More on how and when to deploy TIPS from the same source here:

https://movement.capital/when-tips-outperform-and-how-i-invest-in-them/

 

[njhowie]

But I look at them today, and they pay much lower, approx .5 to 1%.

That is where I have concern, because just like in 2006 companies pay a dividend close to 2% (example VTI) so the relative reward of the TIP has dropped.
I wonder what happens in 3 yrs if interest rates go up to 4% because inflation is 3.5%, My new TIP would pay 1% on a 3.5% increased value so that is good, but surely someone could buy a new TIP paying 3% , so my TIP would have less market value, unless I held it to maturity.

Are these valid concerns to have about TIP's:

My view is that what you are pointing out is simply confirmation of what the purpose of TIPS are - protection against inflation. If that is what you're looking for, then when interest rates are so low, the difference in the coupon on the TIPS vs. regular treasury or CD is going to be pretty minimal. So again, you are getting exactly what you purchased the TIPS for - protection if inflation begins to take off.

1. That they are now relatively more expensive than in the past ?
2. And face a marketplace disadvantage in a rising rate environment similar to regular bonds ?

Yes, and yes.

Again, TIPS are essentially bonds with additional attributes. It is still a bond at it's core and will be subject to the same interest rate risk as bonds. Because of the inflation protection, the volatility relative to regular bonds may be diminished, but it is still there.

 

[bolt]

njhowie, you might appreciate the book "Don't count on it" by JBogle & contributors. The books introduction contains quotes by David Einhorn @ Greenlight Capital, in its day a powerhouse.
He suggests the gov.inflation formula* for the last 35yrs has changed several times.
This is in the books introduction
I suggest you read it all.

I've experienced inflation, as I'm sure many here have. Not overlooking the creative accounting and financial engineering shenanigans involved in its formulas. The pre 1980 formula suggests inflationary measures close to 6-9% over the last 50yrs in USA. His sentiments were stated as considering all aspects of inflation including but not limited to diminished size, diminished quality, etc. following most, but not all products equally.

I agree, inflation is more than a 2% mean annually over last 50yrs.
Good luck & Best wishes.
imo

 

[njhowie]

Oh, I absolutely agree on that bolt...the government certainly under reports inflation so as to serve itself best. Reporting higher inflation means increased payouts to all entitlements with cost of living adjustments.