Vanguard on July 24 filed paperwork with the SEC to launch the Vanguard Short-Term Inflation-Protected Securities Index Fund, and it will come in traditional Investor and Admiral mutual fund varieties – along with an ETF. This fund will track the Barclays U.S. Treasury Inflation-Protected Securities (TIPS ) 0-5 Year Index, and invest in TIPS that have a remaining maturity of less than five years.
The fund is expected to launch around Oct. 10, 2012. The mutual funds will impose a 0.25% purchase fee (which doesn’t apply to reinvested dividends and capital gains). This fee benefits current shareholders, and is designed to discourage short-term trading. ETF buyers will be exempt from this fee.
The management fee for the ETF is expected to be 0.1%, the same as for Admiral shares. So ETF buyers would get Admiral advantages without the 0.25% purchase fee.
You can read the preliminary prospectus here (Admiral shares)
Vanguard’s fund won’t be the first for short-term TIPS. Already launched are:
- iShares Barclays 0-5 Year TIPS Bond Fund (STIP), which tracks the same index, with a 0.2% expense ratio.
- The Pimco 1-5 Year US TIPS Index ETF (STPZ), linked to the BofA Merrill Lynch 1-5 Year US Inflation-Linked Treasury Index. It also has an expense ration of 0.2%.
So the Vanguard ETF will have the advantage in expenses, although slight. However, with the very low returns this fund will offer, that little advantage makes a difference.
Here is how the iShares fund has performed against the Pimco fund over the last year. Keep in mind that the iShares fund will use the same index as Vanguard’s:
The iShares fund has slightly outperformed the Pimco fund over the last year.
These funds are not going to pay much in dividends, in fact, buyers can expect negative returns to inflation over the short term, and possibly much longer. The current 30-day yield on STIP is -0.22%.
Vanguard notes the fund is designed for low-risk investors, but still carries risks:
Income fluctuations. The Fund’s quarterly income distributions are likely to fluctuate considerably more than the income distributions of a typical bond fund. Income fluctuations associated with changes in interest rates are expected to be low; however, income fluctuations associated with changes in inflation are expected to be high. Overall, investors can expect income fluctuations to be high for the Fund.
Interest rate risk, which is the chance that the value of a bond will fluctuate due to a change in the level of interest rates. Although inflation-indexed bonds seek to provide inflation protection, their prices may decline when interest rates rise and vice versa. Because the Fund’s dollar-weighted average maturity is expected to be 5 years or less, interest rate risk is expected to be low for the Fund.
Treasury Inflation-Protected Securities 
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If the 20-year holding term doesn’t bother you, series EE bonds are a great buy today versus a traditional 20-year Treasury, which currently is paying 2.30%, versus 3.5% for the EE, if you hold it 20 years (hold it less than 20 years and you currently earn 0.90%). In a worst case, if rates rose sharply, you could get out of of them after a year with a three-month interest penalty, or after five years with no penalty, and collect that meager 0.9%. Plus no state and local taxes and deferred federal taxes.
I can’t see EE Bonds as my ‘primary’ bond investment, since the term is long and there is no inflation protection. But they are definitely worth adding into your super-safe mix.
I really wonder if the treasury is really going to offer I bonds next year as they are now the best deal in town. I mean, you kill the current 10 year TIPS plus you get tax free accumulation for at least 30 years. You can’t beat that deal now a days. Also, there is the floating rate notes that are coming out next year, I doubt these are as good a deal as the i bonds. I’ve even been debating buying EE bonds, would get 3.5% tax free accumulation if held 20 years.
Yes, the return will be negative to inflation. TIPS carry a coupon rate of at least 0.125%, but if you pay above par value your resulting return is less. With a TIPS mutual fund, your principal is at risk if the yield to maturity on short-term TIPS begins rising. A 5-year TIPS is now paying about -1.271%, and a ‘more normal’ rate would be around 1%, plus inflation. (Even I Bonds still pay zero percent, plus inflation, not a negative rate.) TIPS should pay more because of the tax deferral of I Bonds. But I Bonds are paying a rate that is ‘artificially high’ because the Treasury won’t let them pay negative interest. TIPS have a rate that is ‘artificially low’ because of massive Federal Reserve intervention in the market.
If this new fund buys short term tips at market, they will still, at current rates, have a negative return, correct?
I really wish Vanguard would have a long term TIPS fund being in my early 30s. I currently use VIPSX because it is easier to deal with than buying 30 year TIPS in the IRA and then reinvesting the dividends.