Better inflation hedge: TIPs or Wellesley?

[brewer12345]

Real estate prices are driven mostly by wage inflation

Except for in the last 5 years.

 

[cute fuzzy bunny]

He didn't ask for the opposite scenario -- he was asking about an inflation hedge.

The duration of Wellesley's bonds average 5.7 years. That means if interest rates go up (a la inflation), then the value of those bonds go down 5.7% for every 1% increase in market rates. I'm not sure if that's anybody's idea of an inflation hedge -- certainly not mine.

You simply cannot extrapolate the past performance of Wellesley into the future unless you also assume that the future economic environment and starting conditions are similar. I don't understand why people look to past performance when duration, current interest rates, current inflation, and current dividend yields are much better predictors of future performance.

The focus on past performance almost seems like a hairball sometimes.

So once again, past performance means nothing, so we have absolutely nothing with which to determine asset allocation strategies and appropriate investments?

The "opposite situation" was important, simply because you highlighted the downside half of the investment and why that would suck vs inflation, and neglected the upside half of the investment.

I'm frankly shocked that you'd cherry pick information for the sake of simply sustaining an argument!

The point is, most investors looking to 'hedge inflation' are looking for a conservative place to park their money, ideally in a low volatility situation, with low likelihood of loss of principal, with good returns that exceed inflation and pays a decent dividend.

Seems to me that once you set aside the grunty technical bits and whiny insistences on putting things into small buckets, that Wellesley (and similar funds) meets those criteria nicely.

The one catch, as I mentioned, is Rich's 5 year horizon. If the question was "a good fund for the duration of my existence" for an inflation fighting component, I wouldnt hesitate to recommend something like wellesley as an option.

But then again, except for my recent small foray into ISM (which i'm currently regretting) I wouldnt touch most CPI indexed securities with anything shorter than an 18.2' pole.

 

[wabmester]

So once again, past performance means nothing, so we have absolutely nothing with which to determine asset allocation strategies and appropriate investments?

The "opposite situation" was important, simply because you highlighted the downside half of the investment and why that would suck vs inflation, and neglected the upside half of the investment.

This is getting silly. I've presented you with hard information on why the *average* historical performance is misleading. Others have presented you with data showing how poorly the fund performs during periods of high inflation, including data that disproves your meaningless assertion of "no two sequential down years." And I've presented you with hard data on how you can use current metrics as a *much* better indicator of how the fund will perform in the future.

Everybody knows nominal bonds suck during periods of increasing inflation. Everybody knows that stocks suffer from inflation shocks. A 65:35 bond:stock fund has got to be nearly the worst possible inflation hedge, yet you continue to ignore these facts.

Silly wabbit. Cough up this hairball, will ya?

 

[Rich_by_the_Bay]

The one catch, as I mentioned, is Rich's 5 year horizon. If the question was "a good fund for the duration of my existence" for an inflation fighting component, I wouldnt hesitate to recommend something like wellesley as an option.

I'm inclined to buy your reasoning and logic. What I'll likely do is keep around maybe a year's worth of expenses in TIPs just to get me through a serious inflationary flare. Just can't see TIPs being very good at anything else on my list.

 

[wabmester]

I'm inclined to buy your reasoning and logic. What I'll likely do is keep around maybe a year's worth of expenses in TIPs just to get me through a serious inflationary flare. Just can't see TIPs being very good at anything else on my list.

Rich, I have no interest in persuading you one way or the other, but I am interested in the reasoning behind your conclusion.

You seem to think TIPS are a low-return alternative to nominal bonds. That you'd be sacrificing return for better inflation protection. Is that the core of your reasoning?

 

[Rich_by_the_Bay]

That you'd be sacrificing return for better inflation protection. Is that the core of your reasoning?

More or less, "return" meaning compared to Wellesley, which I presented as an income-oriented benchmark that reflects how the money might be postured if not invested in TIPs.

I'm a nontechnical investor, and have little interest in risk exposure on my fixed investment side -- I leave that to the stock side. Most of it will be in short term bonds and some cash. I see TIPs playing a niche role in modest amounts, which I might welcome if inflation goes to 5% or 6%+ and I don't want to cut too deep anywhere else. I could burn my TIPS fund conveniently for a year or two until other adjustments come into play (reduce expenses, rebalance, etc.)

So this was a pretty interesting discussion for me. What flaws do you see in this logic?

 

[wabmester]

What flaws do you see in this logic?

Well, TIPS are designed to remove risk. Specifically inflation risk. They can't be compared directly to a balanced fund, but they can be compared directly to nominal bonds. Nominal bonds have an embedded estimate of inflation in their yield, and they suffer when that estimate is too low.

Currently, nominal bonds have a very low estimate of inflation. The market could be right about low inflation, and those bonds will perform as well or better than TIPS. If the market estimate is too low, TIPS will perform better. Swedroe has a pretty logical sliding scale on TIPS allocation based on historical real returns from nominal bonds. It's basically what I follow (but I invented it first!), and I'm not very excited about TIPS given the current yield -- wait for at least 2.5% real yield.

If you're looking for a low-volatility all-purpose fund, I think the Vanguard Target series is probably better than Wellesley. You'll get some TIPS, international, small cap, etc in the mix that Wellesley lacks.

 

[megacorp-firee]

Swedroe has a pretty logical sliding scale on TIPS allocation based on historical real returns from nominal bonds. It's basically what I follow (but I invented it first!), and I'm not very excited about TIPS given the current yield -- wait for at least 2.5% real yield.

Where can I find this sliding scale documented? Or can you post here? Thank you.

 

[wabmester]

Where can I find this sliding scale documented? Or can you post here? Thank you.

I had to find it by googling his book. It's on page 226 of his new book "The Only Guide to a Winning Bond Strategy You'll Ever Need."

Real Yield on TIPS: % of your bond allocation

>3%: 75-100%
>2.5%: 50-75%
>2%: 25-50%
>1.5%: 0-25%
<1.5%: 0%

this link might work

 

[cute fuzzy bunny]

Hey Wab...the sky's blue!

During the periods of high inflation, some nominal capital paper loss was experienced by wellesley. During those same years, the sucker was paying out 8-14% as a dividend. I think that in the face of high inflation, a very low risk, low volatility fund paying me those sorts of paychecks in a scenario where I have no need to sell principal shares...I'd be pretty fricking comfortable.

Once those periods declined, the funds principal value rebounded, and then some.

But...you're not interested in a discussion, just an argument. I'm still a little too tired from all this moving of furniture to accommodate you. Maybe next month... :

As far as hairballs, maybe the bigger one in the room is the guy who keeps "backing up the truck" to buy these CPI linked investment products which have incredibly low net yields right now, have for several years, and probably will have low yields for the foreseeable future. Perhaps a little less defense of your errors is in order?

 

[wabmester]

During the periods of high inflation, some nominal capital paper loss was experienced by wellesley. During those same years, the sucker was paying out 8-14% as a dividend. I think that in the face of high inflation, a very low risk, low volatility fund paying me those sorts of paychecks in a scenario where I have no need to sell principal shares...I'd be pretty fricking comfortable.

We're talking past each other. I'm trying to point out the flaw in your reasoning, but either you're not seeing it, or I'm not seeing your logic.

How does a fund pay an 8-14% dividend yield? Is it magic? No. Is it an entitlement because it happened in the past? No.

The fund paid a high dividend back in the days when bond yields were high and stock dividend yields were high.

Today, bond yields are low and stock dividend yields are low. No amount of magic or wishing based on historical data will allow Wellesley to pay a high dividend in this environment. Yet the fund is still vulnerable to the same sort of capital losses if the economy slows down or inflation heats up.

Furthermore, the past returns of Wellesley were boosted by two additional historical factors: a declining interest rate environment (from very high yields to today's yields) which provided captial gains to bond returns, and an expanding P/E environment which provided capital gains to stocks beyond those warranted by the economic fundamentals.

To assume that the fund will perform the same going forward is nothing more than voodoo investing. Good luck (or good mojo, I guess) with that one.

 

[clifp]

WAB, CFB you guys seem to be arguing past each other, and I am not sure you are even answering Rich's question.

Fundamentally WAB is correct the only worse inflation hedges than a fund with a 65% intermediate bond allocation is a fund with 100% long-term bonds. AFAIK both medium and long-bond holder during the Weimer Republic suffered a basically a total loss. So in theory Wellesley, is frankly a horrible investment if you fear high inflation. The M* report on it says "All the same, investors should be mindful of its above-average sensitivity to rising interest rates."

That being said, Rich's real question is how do I protect my real income (not portfolio value) during times of high inflation. CFB points to Wellesly's remarkable performance over a 37 year period, about the same length of time as typically early retirement planning horizon. Over a long period of time, and through many different types of market Wellesly distributed a growing and steady income stream to investors.

Now is the due to luck on the part of Wellesly's managers of having a bunch of favorable trends during their tenure, or some skill on their part by adroit money managemen? I don't know for sure, but with a 20 year tenure I don't think it is pure luck.

 

[wabmester]

Now is the due to luck on the part of Wellesly's managers of having a bunch of favorable trends during their tenure, or some skill on their part by adroit money managemen? I don't know for sure, but with a 20 year tenure I don't think it is pure luck.

Alec provided a nice analysis of Wellesley in another thread. There is no alpha attributable to management. Performance was explained by the allocation to large value and bonds.

If we were having this discussion in 1980, when yields on both stocks and bonds were high, I'd be giving Wellesley two thumbs up. Not today, and definitely not as an inflation hedge.

 

[clifp]

I found Alec's analysis here http://socialize.morningstar.com/NewSocialize/asp/FullConv.asp?forumId=F100000015&convId=160983&t1=1148068791

Understanding regression analysis is hard for me on the best of days, but today while suffering from a hangover it ain't going to happen .

I agree with you as inflation hedge Wellesley's isn't a good choice, not sure I'd dismiss it quite so quickly as place for a retiree to invest conservatively for income, and with a ER of .15%, you aren't making a financial advisor rich!

 

[wabmester]

I agree with you as inflation hedge Wellesley's isn't a good choice, not sure I'd dismiss it quite so quickly as place for a retiree to invest conservatively for income, and with a ER of .15%, you aren't making a financial advisor rich!

Heh. If the question posed was "is Wellesley a reasonable low-cost 40/60 balanced fund?" then you wouldn't have heard a peep from me.

But if you're looking for income and stability of principal, I'd probably use an even mix of TIPS and nominals. The smidgen of large value is probably fine too, but today the market is dominated by large value, so the Target Retirement series looks better to me.

 

[cute fuzzy bunny]

We're talking past each other. I'm trying to point out the flaw in your reasoning, but either you're not seeing it, or I'm not seeing your logic.

Sorry, but I dont see the flaw in investing in a product that has a nearly 40 year run of defeating average inflation by 8 percent per year, with very little volatility or loss risk, with a high annual dividend payout that also exceeds average inflation.

Thats not a good inflation hedge?

Really?!?

Why, because its not linked to CPI? Because for brief periods high inflation and presumably concurrent rising interest rates will dampen returns so that they're merely 3-4 points higher than the actual inflation rate? Because 30 years ago we had a high inflationary period the likes of which we're unlikely to ever see again?

You're right...someone has a logic flaw.

As far as this continued twanging of the 'past performance' string...do note that persistence generally beats any predictive approach...but if you insist on saying that a fund that has a track record that runs through bull and bear markets, high and low inflation, stagflation, sideways markets, market crashes, high and low interest rates (et cetera...) as being no sign of future results...

Gosh...what else do you want? Godzilla? Return of the Black Death? Maybe with a little of the Red Death thrown in?

I know you love buying those cpi linked products and getting paid 5% (or less) during the fed mandated neutral inflation periods. Wellesley investors are enjoying nearly that much in current yield, plus a pretty nice capital rate of return...what is it...about 12+% this past year alone? From a bond fund with a little equity thrown in?

Jeez...through me in THAT briar patch.

 

[wabmester]

As far as this continued twanging of the 'past performance' string...do note that persistence generally beats any predictive approach...but if you insist on saying that a fund that has a track record that runs through bull and bear markets, high and low inflation, stagflation, sideways markets, market crashes, high and low interest rates (et cetera...) as being no sign of future results...

Persistence? Are you just making this stuff up as you go along?

2006 was a good year. 12% is not bad at all. 2005, the return was 3.4%. What was inflation that year? Oh, look, it was 3.4%. The fund had a real return of 0%. Some inflation hedge, eh?

Take a look at those vaunted dividends from the fund in the last decade or so. 7%, then 6%, then 5%, then 4%. Oops, persistent trend not looking so good.

I suppose if you want to drive your car by looking in the rear view mirror, that's your prerogative. Just beware that your yield-based shock absorbers are shot. Your fund with 65% nominal bonds might not handle those inflationary bumps are well as she used to....

 

[chinaco]

Which do you think would be a better choice to hedge inflation: TIPs or a well-diversified income/dividend fund like Wellesley (65:35 bonds:dividend stocks)?

Assume a 3 to 4 year horizon meaning you could hold off withdrawing for that many years of inflation if necessary.

Doc, are you talking about a portion of the portfolio or all of the portfolio? Could you describe your goal a little better? Depending on what you are attempting to do, the answer could be both!

You indicated 3-4 year time horizon. Is that to draw down 4% of the portfolio or 100% of the portfolio (or portion of the portfolio)?

The number of years of the draw down period matters as well as the amount of draw down. I know that you are already aware of these issues... But understanding a few more parameters will help.

All of the assets you listed are inflation hedges in the sense that stocks generally outpace inflation over the long haul. Bonds tend to have inflation considered in the price/coupon. TIPS float based on the CPI-U.

If we have hyper-inflation (and depending on what things have inflated prices)... TIPS may not even help. General Market reponse to Hyper-inflation would be volitile (especially short-term) until investors could get a handle on the situation.

 

[mathjak107]

i like fidelity fsrrx strategic real return as my inflation hedge. not as volatile as a commodities fund

 

[cute fuzzy bunny]

Oh dear, once again I think we're stuck on the technicals and all things having to be equal to some formula that allows us to be correct in yet another argument.

I thought hedging against inflation meant making more money, preferably lots more, than the inflation numbers were hitting us with. Not for a quarter, six months or a year, but decade on decade.

You can choose to do it the way Nords and I do, by holding predominately equities and waiting out the volatility, the way many others do by playing "not to lose" by putting most of your money in CPI indexed securities, making 2% over CPI and hoping you die before you run out of money, or some middling strategy where you put 5-50% of your money into the CPI indexed securities, which really buys you insufficient "hedging" of "inflation". I guess its okay during long periods of lousy equity performance and very high double digit inflation, but are you really going to enjoy seeing your pals making 8-12% every year for the decade or two between those periods?

I think not. Obviously I take the high return, long term approach. Others are afraid of "losing" their money to capital depreciation. Others want to try to throw the ball down the lane up the middle of the split, which I dont really get.

Some might want to get a great return with limited "loss" potential, low costs, from a fund thats gone through every thick and thin and still done well. And beat the living hell out of inflation in the process.

Low chance of Godzilla showing up. Sorry.

 

[haha]

CFB, you are a very persuasive writer.

Ha

 

[wabmester]

You can choose to do it the way Nords and I do, by holding predominately equities and waiting out the volatility, the way many others do by playing "not to lose" by putting most of your money in CPI indexed securities, making 2% over CPI and hoping you die before you run out of money, or some middling strategy where you put 5-50% of your money into the CPI indexed securities, which really buys you insufficient "hedging" of "inflation".

[...]

Some might want to get a great return with limited "loss" potential....

Wait a minute. Aren't you the guy who was recently crowing about moving to cash and waiting for the S&P 500 to hit 1000?

 

[haha]

Wait a minute. Aren't you the guy who was recently crowing about moving to cash and waiting for the S&P 500 to hit 1000?

Hey Buddy, haven't you heard that consistency is the hobgoblin of small minds? Could you please get with the program!

Ha

 

[brewer12345]

Times like this I am really glad I decided to stay out of the hairball-chucking contest.

 

[Cut-Throat]

Times like this I am really glad I decided to stay out of the hairball-chucking contest.

Lots of fun to watch though!