WIP and TIP: Better than Gold 27 comments
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Since the market’s collapse, there has been a lot of interest in Gold, and for good reason: Very real fears of inflation, deflation and currency devaluation. Investors are looking for a rock-solid way to protect their wealth. This article proposes an alternative to Gold.
If your goal is to maintain purchasing power, limit volatility and to earn a positive real return on your holdings, then you should invest as Central Bankers do the world over. In the past, Central Banks have chosen Gold because of its long history as a universal store of value. Gold has increasingly gone out of favor over the past half-century. Central Banks have reduced their gold holdings in favor of holding foreign currencies.
Gold’s Problems:
- High Volatility: Historically, Gold has been much more volatile than the SP500 index.
- Zero Yield / Zero Growth: Gold does not increase in intrinsic value. In biblical times 1 oz of gold bought a man a very nice suit. In modern times 1 oz of gold still buys a man a very nice suit.
- Waning Interest by Central Banks (major holders).
Central Banks chose assets that provide protection of principle, asset price stability, liquidity, and yield. Central Banks invest in a diversified basket of bonds denominated in several currencies. Currently, the US Dollar is the leading reserve currency, as 66% of all Central Bank reserves are held in dollar-denominated US nominal treasury bonds.
Risks of Nominal Sovereign Bonds (in Dollars or other currency):
- Rising Interest Rates (as rates rise, lower yielding bonds drop in value)
- Devaluation of the US Dollar
- Unexpected Inflation
- Government Default (unlikely in the US, but more likely in some euro-zone and emerging markets)
Solution: Holding a diversified basket of currencies helps to mitigate the risks of currency devaluation and default. Holding inflation-linked bonds mitigates the risk of high inflation.
Key Differences Between You and a Central Bank
- Because they can print as much of their own currencies as they want, they hold their reserves in other currencies. You, on the other hand, want to hold a majority of your assets in your own local currency.
- Because they are investing large sums, that would swamp the relatively small inflation-linked markets, it is impractical for them to put the majority on their holdings into inflation-linked bonds. A small investor, on the other hand could put all of his bond holdings into inflation-linked instruments with very little market impact.
Investment Vehicle - WIP
Name: State Street Global Advisors has a relatively new product called “SPDR DB International Government Inflation-Protected Bond ETF”, symbol WIP.
Description: WIP is a diversified basket of inflation-linked non-US government bonds. It is the non-US equivalent of the ETF TIP. WIP is a convenient way to diversify away from the US Dollar.
Holdings: The largest holdings in WIP are in the developed markets and in Euros and Pounds Sterling. The fund holds a wide basket of currencies including 31% in emerging markets (Brazil, Poland, Mexico, Turkey, South Africa, Chile, Korea, and Israel).
Default Risk: Even though developed country sovereign treasuries are generally considered safe, the funds holdings are at greater risk for default than the US. The riskiest assets in the fund are in Greece (4.33% of total fund assets) and Italy (4.84%) both are currently considered to be the Euro-area’s “sovereign debtors most likely to default.”
Yield & Expenses: The average real yield in the portfolio is 3.01% - double that of US TIPS. The only downside is the pricey expense ratio of 0.5%.
Fudging Risk: In an earlier article I said that US government is fudging the CPI to make inflation seem lower. The general consensus seems to be that the other currencies of the world for the most part, are much more accurate in calculating their respective CPIs.
A Hypothetical "Lower Risk" Portfolio
Of course, there is no such thing as a risk-free portfolio. Consider a following portfolio consisting of 50% TIP and 50% WIP. Consider the following scenarios, for a US-based investor:
- Should inflation rise either in the US, the rest of the world or globally, your principle is protected.
- If deflation occurs in the US, you are protected by the par value of your bond. CAVEAT: I am not sure how the individual bonds in WIP handle deflation.
- Interest rates could rise. Since TIPS are fairly new (1997) no one has seen how they react in a rising interest rate environment. Normally rising interest rates are due to rising inflation or rising inflation expectations. If so, inflation-protected bonds should maintain value due to their inflation-protection feature.
- The US Dollar could drop in value. You are protected two ways: 1) The WIP account would increase in terms of nominal dollars. 2) Since the US is highly dependent on imports, the decrease in the value of the dollar would cause the price of oil and other imports to rise. Inflation would pick up, and you would be protected by the inflation linked feature of TIP.
- The US Dollar could rise in value. The value of your WIP account in dollars would decrease, however the value of your dollars would increase. Your money would go further with imports.
A more sensible blend of TIP and WIP would be 70 TIP/30 WIP. The only thing that could destroy such a portfolio would be a default by one of the major reserve currencies (Euro, Yen, Dollar, Sterling), or a total world-wide financial collapse much more severe than the one that just occurred. The probability of either of these occurring is pretty slim. We’ve just been through a major financial upheaval and no major reserve currency has defaulted on their sovereign debt.
CONCLUSION: Given WIP’s juicy yield, which helps to counterbalance its high expense ratio, it offers a convenient way to hedge your bond holdings against a US dollar decline.
DISCLOSURE: Author is long individual US TIPS and WIP. You should consult with a professional investment advisor before investing.
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I wrote about this in an earlier article in SA, called
"TIPS: Good in Deflationary and Inflationary Times"
Others believe that the CPI fudge factor could be as high as 3%/year. I believe that the CPI is only fudged by appx 1% per year. As I said in the article, it seems that WIP is based on a basket on CPI indexes which are caluclated more honestly. Thus, it is another reason to diversify into WIP.
On Apr 30 01:09 PM realold wrote:
> Please correct me if I am wrong, but I believe that the TIP "appreciation"
> due to inflation is computed by the government CPI which can be and
> easily has been divorced from realities of inflation. i.e. Obama
> will decide how much your TIP is worth. Is that a risk? More like
> a given.
I am not sure, but I believe the distinction is between NEW TIPS bonds and mature ones. The ETF TIP holds many mature TIPS Bonds that have built up a inflation payments in them. In a mature bond, deflation will erode any of the previous inflation built up. So if a bond has gotten hit with 4% inflation and later 4% deflation occurs - then there is no inflation adjustment premium paid. However, should I bond be hit with 4% inflation then 8% deflation, the bond should have the same exact effect. In other words you cant be penalized for Net Positive Deflation.
On Apr 30 01:11 PM No Free Cake wrote:
> Author writes: "If deflation occurs in the US, you are protected
> by the par value of your bond"
>
> I write: This is only true when holding TIPS bonds directly. It
> is not true when holding TIPS in a fund or ETF (like VIPSX or TIP).
> Funds/ETFs holding TIPS adjust valuation up/down for inflation/deflation
> and is reflected in the periodic distributions. This explains why
> the distributions from these funds/ETFs have been so meager of late.
We are rightly suspicious of how the inflation figure in the US is manipulated for political convenience. But how much does anyone here know about how inflation is calculated for the foreign bonds in question?
That question aside, 70/30 sounds about right. The US is set up for at least double the inflation of Europe, even with the fudging.
This has significant consequences in taxable accounts. In the case of direct ownership of bonds, you must pay tax on the accreted amount of the inflation adjustment. Since you are not paid the adjustment in cash (only the real coupon rate), you must pay the tax with cash from somewhere else. If you hold the securitized form, all the adjustment (real interest and inflation) is paid out in the distribution so you receive enough cash to pay the tax.
On Apr 30 02:10 PM Living4Dividends wrote:
> Since the ETF is merely the sum of its individual bond holding wouldnt
> it stand to reason that all benefits, cap gains, interest and CPI
> adjustments flow directly into the pocket of the ETF Holder?.
am also intrigued on no distributions in four months
are all sovereigns in default?
us.ishares.com/product...
Note the "missing" distributions between Oct and Apr. The US Govt did not default.
On Apr 30 05:08 PM mangy cat wrote:
> like mjgrand3
> am also intrigued on no distributions in four months
>
> are all sovereigns in default?
By way of full disclosure, I own all three sectors, Canroys, shippers, and foreign sovereign debt.
On Apr 30 09:09 AM Walter1234 wrote:
> 3.01% is a juicy yield?
Additional thought: why does a U.S. investor need protection against foreign inflation?
Additional thought: why does a U.S. investor need protection from inflation in non-U.S. currencies?
PS - it's funny - I agree with you that during the debt securitization bubble years (2001-2006) Morgan, Goldman, Citi were really just large hedge funds. It's a deception for them to claim they are commercial banks.
On Apr 30 03:44 PM Mad Hedge Fund Trader wrote:
> Robert Heller agrees. I met with one of my old college professors
> last night, Dr, Robert Heller, former CEO of Visa and governor of
> the Federal Reserve Board. Dr. Heller thinks that the next crisis
> to hit the financial markets will be a spike in interest rates similar
> to one that took the prime rate up to 20% in the early eighties.
> Obama is running the printing presses at such a furious rate that
> an explosion in inflation in 2011 or 2012 is virtually guaranteed.
> Treasury bond markets will get decimated. The only way to protect
> portfolios from this deluge is to buy low yielding Treasury inflation
> protected securities (seekingalpha.com/symbo...). The US
> needs large banks with a global presence to stay internationally
> competitive. Dr. Heller argued that the only regulatory solution
> to the current melt down of the financial sector is to fence off
> the risk and deposit taking operations of the big institutions. The
> extreme volatility caused by hedge funds is keeping the “real” long
> term investors, individuals and pension funds, away in droves. I
> think this means that Morgan Stanley (seekingalpha.com/symbo...)
> and Goldman Sachs (seekingalpha.com/symbo...) will have to
> stop pretending to be banks and “come out” as the mega hedge funds
> they really are. The only professor to ever give me an “A” in an
> economics class, Dr. Heller still has the same fire he possessed
> at UCLA 35 years ago.
On May 01 02:56 PM John Doe2 wrote:
> One-year performance as of 3/331/09 was -20.59%. WIP's inflation
> protection is swamped by the volatility that exists in currency markets.
> In fact, as far as asset allocation goes, WIP should be considered
> a currency play, rather than a fixed-income investment. As a currency
> play, WIP can provide some diversification in an investment porfolio.
>
>
> Additional thought: why does a U.S. investor need protection against
> foreign inflation?
> Additional thought: why does a U.S. investor need protection from
> inflation in non-U.S. currencies?
Good Question:
Because high inflation in that country will eventually cause that countries currency to depreciate against the dollar, thus your dollar returns will be lower. Given the intrinsic inflationary nature of all fiat currencies, I feel that when buying bonds most investors would be well-suited to have inflation-protection built into those bonds.
I do only invest in TIPS. I hold quite a few dividend paying stocks as well. I only mentioned TIPs for those seeking an alternative to gold. TIPS are good for bond portion of the portfolio.
On May 05 12:13 PM dividendgrowthinvestor wrote:
> fianancial indpendence through dividend investing. I prefer the right
> dividend stock to TIPS personally but agree that inflation is inevitable.
On May 05 12:13 PM dividendgrowthinvestor wrote:
> Love the name dividends4life ,since I am a person who has achieved
> fianancial indpendence through dividend investing. I prefer the right
> dividend stock to TIPS personally but agree that inflation is inevitable.
> Stocks have eearnned over 6.5% above inflation since 1802 and Iam
> confident that my stockpicking ability will easily beat the 6.5%
> return and it has for the past 15 years.
A posted Bill Gross's article on the accuracy of Foreign TIPS versus the accuracy of US TIPS. You can find it on my blog at the following link:
seekingalpha.com/insta...
On Apr 30 01:09 PM realold wrote:
> Please correct me if I am wrong, but I believe that the TIP "appreciation"
> due to inflation is computed by the government CPI which can be and
> easily has been divorced from realities of inflation. i.e. Obama
> will decide how much your TIP is worth. Is that a risk? More like
> a given.
Increases in TIPS value due to inflation will help to offset this decline, but by how much? That would seem to depend upon the term of the TIPS bond purchased vs. the near-term effects of inflation.
So, TIPS have the same down side as regular treasuries, but have an up side as well if there is inflation. But the popping of the treasury bubble is probably a more certain thing than high inflation, given the dire economic situation, which holds many deflationary aspects.
Anyway, I'm no expert at all in this, but these are the thoughts that occur to me when reading your article.