Not so well, it turns out, slammed by a decade of lower-than-expected inflation.
By David Enna, Tipswatch.com
Today we will take a look at CUSIP 912828QV5, a 10-year Treasury Inflation-Protected Security that originated on July 15, 2011, with a real yield to maturity of 0.639%. It matured on July 15, 2021. The question: How did it do as an investment, versus a nominal 10-year Treasury note?
I’ve been tracking the performance of every maturing 5- and 10-year TIPS on my Tips vs. Nominals page, and for much of the last decade-plus, TIPS have been a fairly lousy investment, at least versus a nominal Treasury of the same term. The reason: Inflation expectations at the time of issue ended up being higher than actual inflation over the term of the TIPS. When inflation lags expectations, TIPS perform poorly.
Back on July 11, 2011, CUSIP 912828QV5 auctioned with a real yield of 0.639% and a coupon rate of 0.625%, terms that look super appealing today. Yet it’s hard to believe that 0.639% was the second lowest 10-year TIPS auction result in history, up to that point. In July 2011, we were just entering a decade-plus era of Federal Reserve intervention in the bond markets. Just six months later, in January 2012, a new 10-year TIPS auctioned with a real yield of -0.046%, the first of nine straight auctions of this term with a negative real yield.
The key factor in judging the performance of a TIPS versus a nominal Treasury is the inflation breakeven rate, the spread between the real yield of a TIPS and the nominal yield of a Treasury. That spread represents a prediction from investors about future inflation. Unfortunately, this prediction is almost always wrong, too high or too low. And for the last decade, investors have been betting on higher inflation than actually resulted.
Here are the data for maturing 10-year TIPS:
Although CUSIP 912828QV5 had an appealing real yield of 0.639%, on the day of the auction the 10-year Treasury note was yielding 3.03%, creating an inflation breakeven rate of 2.39%, rather high for that period. Ten years later, inflation had averaged just 1.8%, meaning that the TIPS under-performed the nominal Treasury by 0.59% a year.
Investors in this TIPS ended up missing out on a strong month for inflation, because inflation accruals for a TIPS are set by inflation two months prior to the accrual. So, this TIPS did not get a bump from a 0.93% increase in non-seasonally-adjusted inflation in June 2021. If June had counted, the annual inflation rate would have risen to 1.9% and the variance would have dropped to -0.49%.
Some thoughts and qualifications
We just completed a decade-long period of inflation running at less than 2.0%. In general TIPS out-perform nominal Treasurys when the inflation-breakeven rate drops below 2.0%, especially for 10-year TIPS. But the next decade could be entirely different. Never predict the future decade based on the performance of the past decade.
Also, this chart is an estimate of performance, because it uses a full month of inflation in the ending month, when actually TIPS accruals are based on a half month for the first and last months, with the origination and maturity occurring on the 15th of the month.
Keep in mind that interest on a nominal Treasury and the TIPS coupon rate is paid out as current-year income and not reinvested. So in the case of a nominal Treasury, the interest earned could be reinvested elsewhere, which would potentially boost the gain. For certain, we don’t know what the investor could have earned precisely on an investment after re-investments.
In the case of a TIPS, the inflation adjustment compounds over time, and that will give TIPS a slight boost in return that isn’t reflected in the “average inflation” numbers presented in the chart.
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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.