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iShares TIPS Bond Message Board

  • a_samel a_samel Feb 23, 2010 8:04 AM Flag

    Duration

    According to the Ishares website, the duration has jumped from 4 to 7 in the past few days. With the upcoming interest rates increase, does this concern anyone else?

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    • Here's one of the best articles I've seen regarding TIPS. It was written in 2005.

      http://www-stat.wharton.upenn.edu/~steele/Courses/434/434Context/TIPS/TipsGE2005.pdf

      Of particular note is "Figure 5 - When to Buy TIPS".

    • "BTW, I also have a degree in physics (BS) and computer science (MS), and am retired (off of investing)."

      And here we both are on the same TIP message board? That is definitely spooky! :)

      "I don’t understand why a deflationary depression would hurt TIPS or why TIPS went down so much in late 2008. My understanding is that TIPS principal is indexed to inflation, but is protected from going below par."

      I can definitely clear this up for you.

      1. The bonds inside TIP have appreciated due to inflation. They can therefore give up those inflationary gains back down to their par value. "Used" TIPS are therefore dangerous. New ones bought directly from the government and held until maturity are not.

      As an example, let's say I buy a 10-Year TIPS and inflation pushes its price up by 10%. I then sell it to you. My 10% profit is locked in. If deflation struck, you could lose 10% if the bond returns back down to its par value though. TIP holds a variety of TIPS that have appreciated in price due to inflation. That appreciation can permanently vanish during deflation.

      2. Even the bonds bought directly from the government can fall below par value temporarily. You are only guaranteed to get all your original principal back at maturity. If deflation hit with a vengeance, then the interest you would get from each bond would be reduced dramatically as the interest is tied to the inflation adjusted principal (which can temporarily be below par value). In that event, you'd have a harder time selling your bond to someone else. That said, you should still root for deflation though. A decade of serious deflation with the guarantee to get all your principal back at the end would clearly be a win overall. It's just that you could have done better elsewhere.

      3. TIPS are priced based on real yields. If you buy a 10-Year TIPS with a real yield of 1.2% and then real yields spike up to 3.2%, then selling your TIPS to someone else is going to give you a huge loss. That's 2% per year in missing interest. The only way you can sell it is to lower the price to the point the overall yield is comparable.

      This last one is not one I worry about much. I buy directly from the government and hold until maturity. If real yields spike up I won't actually lose money. I will have only lost the opportunity to have done better. No big deal!

      "Also, on your point 4., low interest rates and higher inflation make TIPS especially appealing, doesn’t it?"

      Yes. Points 1 and 2 hurt TIP. Points 3 and 4 help TIP.

      "Isn’t GJO much better than TIPS?"

      I know next to nothing about GJO so I can't really comment on that. I do know that I've been fearful since 2004 and TIPS seemed like a decent choice for all environments. I can sit in TIPS, can root for lower interest rates and/or deflation, while having some inflation protection too. I can also bypass all middlemen looking to make money off of me by buying the TIPS directly from the government. That's appealing to me.

      My favorite investment over the last decade has been I-Bonds though, since they are tax deferred. That could be VERY important if inflation does pick up in a major way. Unfortunately, the government understands this. The rates have dropped to pathetic levels and they have reduced the amount we can buy each year by 83%! I still buy them though. Sigh.

    • I looked at the individual holdings today and here's a glimpse of the maturity of bonds the fund was holding as of 2/25/10.

      0-5 Year: 39%
      5-10 Year: 31%
      10-15 Year: 6%
      15+ Year: 24%

      That's a fairly odd distribution.

      39% of the fund is in TIPS with a maturity of less than 5 years. I see little value here. According to Bloomberg, the 5-Year TIPS has a real yield of just 0.21%. That's pretty much rock bottom since 0% is the floor. Further, if interest rates begin to rise at some point, this end of the curve is where they will begin to rise the fastest. Investors in short-term TIPS can be hurt. We saw 4% real yields on 5-Year TIPS as recently as late 2008 (when deflation struck last time). It can happen again.

      Interest rate risk is a combination of the duration of the bonds and the amount the interest rates can rise. Although short-term TIPS don't have much duration, there is plenty of room for interest rates to rise (if only just to return to something approaching normal). There's almost no room for short-term TIPS rates to fall. They are already scraping the bottom.

      4% real yields were a great buying opportunity. 0.21% real yields are a great selling opportunity in my opinion. You'll lose money after taxes no matter what inflation does more than likely. 5 years is a long time. A lot can happen. Why lock in such a lousy rate? I have no interest in short-term TIPS at these yields. This fund has a lot of them.

      24% of the fund sits in TIPS with a maturity of 15 years or more. I like the yields out here for the long-term. Heck, I just bought some 30-Year TIPS in the recent auction. The roughly 2% real yield out here is at least decent. However, there is serious interest rate risk here. Emergency cash should never be invested in 15+ year TIPS. I am comfortable holding bonds out here until maturity though, which is exactly what I'm doing.

      I don't hate TIP. I do still it in my IRA. It's the only thing in my IRA. I'm using a dividend reinvestment plan to buy more shares each month. I am not expecting good returns from here on out though.

      I want to own TIP again outside my IRA too at some point. I still have some cash left (from my sale of TIP in November) that I'd like to put back to work. I just want the price to come down a bit further and I'm fairly patient.

      And lastly, I want to make this clear. I do not expect the Fed to be raising interest rates any time soon. Our economy is in horrible shape. Real interest rates can rise again though (much to the dismay of the Fed). All it would take is another deflationary event. It wouldn't even have to be centered on the USA. China comes to mind, or maybe Greece's problems spread like an infection. Who knows?

      We are still fighting deflation. You can see it in the following two charts.

      http://finance.yahoo.com/q/bc?s=TIP&t=2y&l=on&z=m&q=l&c=ief

      http://research.stlouisfed.org/fred2/series/TOTBKCR?cid=101

      • 2 Replies to markm0722
      • For what it is worth...

        On 2/27/10, I looked at TIP's holdings and saw the following.

        0-5 Year: 39%
        5-10 Year: 31%
        10-15 Year: 6%
        15+ Year: 24%

        Today, I look and see this.

        0-5 Year: 36%
        5-10 Year: 32%
        10-15 Year: 6%
        15+ Year: 26%

        Back then I said...

        "24% of the fund sits in TIPS with a maturity of 15 years or more. I like the yields out here for the long-term. Heck, I just bought some 30-Year TIPS in the recent auction. The roughly 2% real yield out here is at least decent. However, there is serious interest rate risk here. Emergency cash should never be invested in 15+ year TIPS. I am comfortable holding bonds out here until maturity though, which is exactly what I'm doing."

        Hindsight has been very kind to me so far. The 30-Year TIPS is up roughly 12% since I bought in February.

        Much of the rise in TIP's price can be attributed to the 24% of the fund that was in the longest dated maturities. Investors opted to accept lower long-term real yields in the face of continued economic weakness.

        I also said...

        "We are still fighting deflation."

        That is also holding up well in hindsight. The seasonally adjusted CPI-U peaked at 217.591 in February. As of May, it is only 217.224. That's a decline. That's deflation. It isn't much, but it is there to see.

        http://research.stlouisfed.org/fred2/data/CPIAUCSL.txt

        As of May 2010, the CPI-U sits at 217.224. That's exactly where it was (right down to the last digit of precision) in December 2009. That's 6 full months of nothing.

        Should that 6 full months of nothing continue, TIP will struggle to appreciate in price and offer very small distributions. I have TIP in my IRA. I'm fine with that. I'm just trying to preserve capital.

        Those expecting 10% returns in TIP from here will continue to be disappointed though. Even if they end up being right, inflation would not help any of us. It would simply lower our inflation adjusted returns once taxes are considered.

        This is best case scenario for us as savers. No inflation to speak of combined with small real returns. There's little the government can tax.

      • Markm - You do some really complete and impressive research - are you a professional investment advisor or analyst ?

 
TIP
113.25+0.10(+0.09%)Nov 25 4:00 PMEST

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