Do TIPS ETFs Make Sense? 14 comments
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It’s quite clear that Pimco is talking its book when it says that active management makes more sense than indexing if you’re buying TIPS. On the other hand, Pimco’s arguments are quite compelling — more compelling, indeed, than counterarguments which don’t really address what Pimco says and instead fall back to the standard passive-investing-is-always-better approach.
The WSJ came to exactly the right conclusion, I think, after looking at the numbers:
Over the past five years iShares Barclays TIPS Bond posted an average annual return of 4.28%, according to Morningstar. That is slightly better than the 4.14% return on the Pimco Real Return fund’s “D” shares, which investors can purchase through a discount brokerage account.
But as always with mutual funds, costs are key. Investors with access to the Pimco funds’ “institutional” shares through a large company retirement plan would have outperformed the ETF, while those in one of the load-paying broker-sold shares classes would have done significantly worse.
I’d only add that it’s crucial, whenever you’re dealing with TIPS, to understand the tax consequences of investing in them — that can make a huge amount of difference, and it’s not uncommon for investors to avoid TIPS entirely just because they can’t deal with the concomitant tax hassle.
As for bond investing, there’s an extra layer of complication here in that it’s very hard to come up with a good index: you can’t just buy-and-hold bonds, as you can with stocks, because that way your duration is constantly declining. As a result, it’s far from clear what constitutes outperforming or underperforming — everything just becomes relative to other investors’ performance.
Still, I’ll stick to the ETFs, just because they’re easier to understand and it’s less likely I’ll be ripped off or subject to some managerial blow-up. My gut feeling is that individual investors are generally foolish to seek outperformance — which is ultimately what Pimco is selling here. And that anybody who can outperform a little can underperform a lot.
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TIPS are indexed to THE GOVERNMENT's calculation of inflation.
Does anyone really trust the government's inflation measurements?
If you can pull that off, it makes sense to have a meaningful chunk of TAX-FREE RETIREMENT ACCOUNTS accounts in real return bonds (particularly so for those with partially indexed pensions which inevitably will fall behind if you are unfortunate enough to live beyond expectations).
I'm curious what your thoughts are regarding WIP? If you're buying TIPS, then obviously you're concerned about inflation (something I'm beginning to question) so would you think that diversifying across different governments' interpretations of inflation would be better than only relying on the US?
Gold? No thanks. Currency baskets? Too complicated. Treasuries? Wait...that's why we're seeking inflation protection for our cash in the first place.
On Aug 18 09:02 PM D. McHattie wrote:
> I don't know why anyone would invest in TIPS in any way, whether
> through an ETF or managed fund.
>
> TIPS are indexed to THE GOVERNMENT's calculation of inflation. <br/>
>
> Does anyone really trust the government's inflation measurements?
There is GDX for gold producers, many of which also produce silver.
There is MOO for agriculture.
There is PBW for alternative energy but there is a whole slew of energy ETFs out there.
Or invest in established individual companies like POT for agriculture, CCJ or COP for energy, Barrick or Newmont for gold.
I'm not trying to be argumentative here but I think the government's inflation measurements and general unreliability make TIPS the ultimate sucker's bet in this environment.
Just my opinion, which, admittedly is very negative towards government.
On Aug 18 11:58 PM Ricard wrote:
> As interesting as all this negative sentiment may be, my question
> for you would be 'what is the alternative'?
>
> Gold? No thanks. Currency baskets? Too complicated. Treasuries? Wait...that's
> why we're seeking inflation protection for our cash in the first
> place.
Gold - no yield, carrying cost, manipulation/central bank actions
Commodity ETFs - no yield, contango costs
Resource companies - don't capture full inflation, correlated with stocks
TIPS have their place in the basket. As for fund choice - you could pay a lot for "seeking alpha".
WIP is a new product - a global ex-US real return bond fond comprised of real return bonds from a variety of developed countries. The inflation adjustment will therefore vary across countries according to their national (GOVERNMENT CALCULATED) inflation rates and I have not seen any satisfactory analysis of how this might work out over the medium and long term. There is also the unknown impact of currency fluctuations (you are essentially also buying in to a basket of currencies). Finally, impossible to know just how well this product really performs until a number of years have passed. Let me just say that the market price of this product fluctuates much, much more than is the case with the real return bonds that I hold directly.
First, a little over a year ago when the price of oil was peaking and inflation was the great concern, the ETF TIP hit its record high and was showing a historic dividend of 9%. One can understand the price going so high but the explanation for the dividend is another matter. Even with the CPI adjustments, there is no way the interest payment coming from the underlying TIP bond ever reached 9%.
Second, once the inflation talk had made the rounds, as journalists began thumping TIPS, and as the first hint of the recession became
evident with oil and the credit markets going into a dive later in the summer, something even more unusual happened to TIPS. The monthly payments stopped, and did so for five months. So if you were thinking that you would buy TIP ahead of the next correction back into inflation and would be rewarded with some payment, you had nothing starting after October 1st until the end of March. Neat.
The sponsors of these ETF's have not done a good job explaining the wrinkles of these products, and the media that gets paid to run ads for Barclarys and State Street do little to examine the products. The "financial advisors" rarely own the products themselves so they have no clue as the nature of what they are recommending.
I realize this comment does not address the PIMCO question raised by the author, and I also realize that by writing this note two days after the article was published, it most likely will not be read, but if someone is researching the ETF called TIP and runs across this article by Felix, I hope he or she takes the time to read this note as the performance history quoted above unfortunately perpetuates the same lack of detail found in so many of the mainstream media stories, which is not why readers typically visit this post.
FAMCO
"I’d only add that it’s crucial, whenever you’re dealing with TIPS, to understand the tax consequences of investing in them." ...
This is a crock of crap. The tax consequences of TIPs are the same as those for bonds. The problem with TIPs is that they generate phantom income because the investor has to pay taxes on the inflation adjustment (even though the inflation adjustment is not paid in cash until the bond matures). The only sensible place to hold TIPs is in a tax-sheltered account.
Felix Salmon wrote:
"Still, I’ll stick to the ETFs, just because they’re easier to understand"
Not true! An ETF is more complicated to understand than the underlying bonds. Why does anyone need an ETF to hold TIPs ? ETFs do offer superb diversification at low cost for nearly every other asset category. However, since TIPs are all from the same issuer, the US Government, there is little diversification benefit to be gained from holding an ETF. The only diversification is maturity diversification, and this can be solved by buying a handful of individual TIPs bonds with differing maturities. In fact, if the person retires in X years, they can tailor duration to their retirement date.
Felix Salmon wrote:
"As for bond investing, there’s an extra layer of complication here in that it’s very hard to come up with a good index: you can’t just buy-and-hold bonds, as you can with stocks, because that way your duration is constantly declining. "
You said that you can't buy-and-hold individual bonds? Are you serious? This is investing 101 - basic stuff.
A portfolio of individual bonds, held to maturity, is the classic way old-fashioned way to fund a retirement. Your returns are guaranteed (at least with govt bonds). What is not guaranteed is purchasing power. TIPs attempt to solve that last problem. Despite the claim of cheating on the CPI, we are not going to get into a situation where inflation is running at 18% and the government says "Hey folks, inflation is rosy 4% this year." They can fudge the figures, but not that much. There would be a revolt! Perhaps the CPI calculation isn't 100% accurate. But at least, worst case scenario and the the CPI calculation is pretty mucked up, there is PARTIAL inflation protection. With regular ordinary bonds you get zero protection.
With a few bonds you can tailor duration to exactly where you want it to be. Reinvestment of coupons is a problem but the "small change" can be swept into a TIP ETF.
I've stuck with mutual funds for bond holdings, as it makes the reinvestment much easier and cheaper. The mutual fund fees are lower than the brokerage fee's of reinvesting interest income (at least for a holding as small as mine).
Is there something else I'm missing?