Yes, it has been a bad year for Treasury Inflation-Protected Securities, but as I will explain, it all depends on how you define ‘bad.’ As a buy and hold-to-maturity investor in TIPS, with a ladder crossing many years of maturities, I don’t really worry much about market swings after I make my purchase.
The Wall Street Journal last week gave an article about TIPS fairly major play: ‘TIPS Poised for Worst Year Ever.‘ The article pointed out that TIPS underperformed traditional Treasuries this year, mainly because TIPS were overbought through 2012, pushing yields negative to inflation. And then, inflation fizzled:
For years, TIPS owners accepted negative real yields, expecting they’ll get compensated down the line when inflation rises. Payments on TIPS increase as the consumer-price index rises. Now, not only is realized inflation in the economy still tepid, but the Fed’s inflation-inducing stimulus program looks set to wind down without having stirred up much inflation at all.
Quite frankly TIPS got way too expensive from July 2011 to about April 2013. I simply stopped buying during that time, and I got completely out of TIPS mutual funds, way back in 2011 (too early, I admit). But that changed this year, as yields improved:
- I again started buying TIPS at auction – cautiously in the May, July and September auctions, mainly to fill holes in my TIPS ladder caused by two years without purchases.
- On June 21, I reestablished small positions in the Vanguard and Fidelity TIPS funds, and I am dollar-cost averaging contributions in IRA accounts. On June 21, the TIP ETF stood at $110.44 and today it trades at $111.19, so most of the damage was done by June 2013.
TIPS mutual funds, especially, have been hard hit, with the TIP ETF dropping 8.5% so far in 2013. Yields started rising in the summer, as fears rose that the Federal Reserve would stop its bond-buying stimulus program. Back on June 9, when the TIP ETF stood at $114.64 and the 10-year Treasury was yielding 2.22%, I wrote this (call me psychic):
My theory is that the 10-year Treasury could rise to about 2.75% by the end of the year, and if it does, that would set the 10-year TIPS yield at about 0.5%, about 47 basis points higher than it is today. If that happens, the TIP ETF would fall another 4%, or maybe to the $111 to $110 range. At that point, I might be a buyer.
And voila, within a month the 10-year Treasury yield hit 2.70% and the TIP ETF dropped to $110.50, and I, the psychic, became a cautious buyer.
TIPS mutual funds hit a low-water mark on Sept. 5, when the 10-year TIPS yield soared to 0.92%. Today it stands at 0.66%, 26 basis points lower. I expect that next year, if the economy improves and the Federal Reserve abandons bond buying, the 10-year TIPS yield will begin to ‘normalize,’ possibly somewhere around 1.5% with a traditional Treasury yielding 3.8%.
I laid out my logic in this post back in August: How high will TIPS and Treasury yields rise?
A yield of 1.5% on a 10-year TIPS would be an 84 basis point rise from today’s yield and would cause about a 6% drop in the TIP ETF, giving you a price somewhere in the $104 to $105 range.
I am not saying this will happen, but I do think it could happen, and possibly is likely to happen. In the Wall Street Journal article, J.P. Morgan experts make an even more dire prediction:
J.P. Morgan expects inflation to remain tame next year, seeing year-over-year CPI running no higher than 1.7%. That, alongside an expected 120 basis point rise in real yields, translates into a -8.4% total loss on TIPS in 2014.
Joe, VIPSX is an intermediate-term fund because it indexes the entire TIPS market. It is very similar to the TIP ETF. Vanguard lists its duration at 7.5. Vanguard also has a short-term TIPS fund, the VTIP ETF, that has a duration of just 2.3 years, so it is less risky but also has a lower return.
Do you consider VIPSX a short term tips fund. It has a duration of almost 9 years I believe. I think barclays does have some short term tips funds of a few years and it is possible to lose money if the real yields are negative and inflation is low.
Thanks for this report and dire prediction
I have never owned a TIP mutual Fund
However, I do have a significant investment in an individual TIP shortly after it was issued
It is the 3.875% TIP maturing in April of 2029
The cumulative inflation factor is now at 1.42327
So my Real Yield at the current market value is 2.81%
This TIP has just over 15 years until maturity
And I think that 2.81% real yield is “a good yield” in the current market
Especially for a 15 year treasury
And plan to hold this to maturity
Grant, I also own that TIPS maturing in April 2029. It is a great holding — among the greatest TIPS investments in history. A lot of people would have said ‘sell’ it during the time of recent ultra-low yields, but that isn’t my style either. Hold to maturity and keep it simple. Even with inflation running at 1%, you are still pulling down 4.875% with that TIPS.
Joe, the only problem with short-term TIPS funds is that their total return is extremely low, even negative over 2013. That could improve over time, though, especially if inflation picks up. On the other issue of hyper inflation, the whole nation would be in big trouble if that happened, just about every aspect of American life. So I guess I’d rather hold taxable TIPS than no TIPS at all. Tax-deferred is the best option, of course.
The important thing is if you keep the duration of the your TIPS mutual fund, like VIPSX, you will be okay. The issue is buying when they are expensive and selling when they are cheap. When you buy the TIPS and keep to maturity, there is no issue.
Its impossible to tell how high TIPS will go, I’ve now been buying them individually in my IRA at auction. So for my 2014 roth ira, I will buy the 30 year TIPS at auction in February, should get a better real yield than the 0.625% I got last year. But then again, I plan to keep it until maturity, and it will perform really weel if inflation shoot thru the roof because all the profit will be mine tax free.
I think there is an inherent diasaster risk by keeping TIPS in a taxable account. What do you do if you get Weimer like inflation, That would wipe you out tax wise, I think.
Great blog. Keep up the good work!