The problem with guessing the downside for this ETF is as follows.
1. The notes comprising the ETF have appreciated in value during inflationary months. 2. The ETF distributed these gains as yield in past months (alongside the real yield of 1-2% above inflation) 3. The face value of the notes is rolling back to 100 now that we have deflation. The ETF cannot ask holders to give back the money that was distributed in the inflationary past. Instead, the NAV is recomputed below 100.
So, if you're a long-time holder of TIP you might see downside to the point your cumulative return is down to zero. Alternatively, one can try to add all the historic distributions (minus the real yield of 1-2%) and subtract it from 100 to find the downside.
Then, of course, don't forget that the market can always suffer from "temporary insanity".
I didn't create this (and I lost the source) but it was posted around Oct 24:
"Since the TIP fund dipped below 100 there have been a few threads discussing maximum downside from here but no specific numbers provided so here is my 2 cents.
Avg duration on the TIP fund is about 7. A 10bps increase in real rates of return would mean the price of a TIPS bond will decline by 7x0.1% = 0.7%. So even though you are guaranteed to get par at maturity (in approx 7 years) the price on the bond today will DROP BY 0.7% even if inflation expectations do no change.
What is the max pain? Real rates of return on 10yr TIPS were recently hovering around 3% (see link below) which is the highest in recent history but that does not mean yields cannot go higher. In Canada, real yields on inflation-indexed gvt bonds reached 5% in 1995-1996 (their consumer inflation went to zero at that time). If we repeat this experience in the US, real yields will have to move up 2% from the current 3% level so TIPS price will go down 14%.
In the UK which is also a heavy issuer of inflation-indexed bonds, the actual worst case 1-year return was in 1994 when IL bonds price dropped 8%.
Based on this, I would say worst case the TIP fund can hit 85-90 in the next year. Just giving you a book end for your risk management purposes. I bought in today a first installment and intend to build my position as price declines further. Real rates of return over the last 50 years have been around 2.5% so when things normalize, I would expect TIPS to trade back to about 102-103 and this assuming zero inflation. When the inflationary holocaust descends upon us in 2010 the fund will go even higher, 115-120 perhaps.
To summarize, expect a price decline from here in the next 12 months, possibly as low as 85-90. Going further out, the fund should trade back above 102-103 and possibly much higher."
I am sorry that I did not check my before posting it. Anyway, my premises are (1) regular Treasuries has inflation risk and, credit risk (which due to massive federal deficit, may not be zero), (2) TIPs protects against inflation risk, however, not credit risk, (3) because of a massive wealth destruction, we may have a deflation + a massive credit risk, or (4) hyperinflation + credit risk.
Why would you buy TIP under the (3) and (4) conditions?
Can you give me your opinion on what would happen if, due to massive federal debt, the foreigners refused to buy Treasuries? Let's us hypothetically assume that there would be no inflation.
I would presume that (1) The yield on regular bond would go up and price fall, (2) the inflation portion of the TIP's yield would not go up, however, the real yield portion would go up and price of TIP go fall.
Therefore, if you believe that federal deficit will lead to higher yield on regular Treasuries, therefore, should be avoided, then should you not do the same with TIP, i.e., avoid it?