TIPS: bonds vs bond funds

[wabmester]

I spent a little time tonight trying to calculate some portfolio returns (my port composition makes this kind of difficult).

About a year ago, when the real yield approached 2.5%, I bought a bunch of TIPS.    I love TIPS, so I bought three varieties: new issues from the treasury, old issues from the secondary market, and a little dab of a TIPS fund (VIPSX).

Vanguard says that the 1-year return for VIPSX is 8.72% (avg duration 6.76, avg maturity 10.6 yrs).

My 1-year return on the new 20-year issues was 13.7%.

My 1-year return on some secondary 3.625% (2028) issues was 19.2%.

This shows the power of duration (in this case, for the better).    My portfolio is about 50% bonds, and I really expected TIPS to be a nice boring inflation hedge, so this capital appreciation is a nice surprise.

And I've always said that it doesn't make much sense to buy mutual funds that invest in treasuries when you can buy the bonds directly with no markup and no annual "expense ratio."

A question for you bond wizards: when do you sell?   I generally buy bonds expecting to hold them to maturity.   I hate selling bonds, but I suppose it makes sense in some cases.   I've read about "riding the yield curve" but I'm not sure that really applies here.

Any thoughts?

 

[unclemick]

I thought the yield curve riders generally played with zeros and Strips. Nothing wrong with taking cap gains depending on your take of the future - but then you are in the same camp as the buy low sell high stock cats.

So - in my mind - it comes down to - why do you own the bonds in the first place - income, reserve, part of a slice and dice portfolio, volitility damper, etc.

 

[wabmester]

I thought the yield curve riders generally played with zeros and Strips.

Hmm, I thought the idea was to simply take the cap gain "bonus" off the table before it went to zero at maturity. I'm pretty sure it applies to all bonds when the yield curve is fairly static. I just don't know if you can apply the idea to TIPS, since the real yield curve should be pretty flat in theory (as it is now).

So - in my mind - it comes down to - why do you own the bonds in the first place - income, reserve, part of a slice and dice portfolio, volitility damper, etc.

Well, that's one of the reasons I hate selling bonds -- because appreciation basically means that it's impossible to replace them with equivalent investments. But at the same time, I *know* that there's simply not that much more room for real interest rates to drop from the current 1.8% or so (the long-term historic mean is around 2.5%), so it's really tempting to take some of those gains and wait for regression to the mean.

 

[ats5g]

Hi Wab,

I googled "riding the yield curve" and found this recent paper:

Riding the Yield Curve: Diversification of Strategies (may be helpful)

I don't know if this is going to help or not.

FYI - I didn't know that one can sell Treasuries through The FED through Sell Direct

Personally, I'd just keep those TIPS. 8)

- Alec

 

[unclemick]

Somebody correct me if I'm wrong - but the zero cats picked points( buying and selling) along the yield curve based on their take on interest direction. Holding to maturity - was insurance - to get your principle back in case you were wrong.

Now - coming to short maturities was for rising rates - in which case you didn't make that much - while waiting for a falling trend(short, intermediate, long) to develop - where the cap gain was the gravy.

My memory probably has this wrong - so will the real bond cats please step forward.