Cliff Reynolds'  Instablog

Duration measures a bond’s price sensitivity to changes in yield. If you need a refresher check out my duration article from a few weeks ago.

 Because TIPS trade on a real yield basis, their duration measures their price sensitivity to changes in real yields. The first quarter of this year was a good example of how the performance of TIPS and Nominal Treasuries can differ when real and nominal yields go different directions.

The yield on the nominal Treasury rose about .18% for the quarter, while the real yield on the 10yr TIP was unchanged. Put another way, inflation expectations for the next ten years jumped by 18 basis points. As a result, TIP (iShares TIPS Bond Fund) outperformed IEF (iShares 7-10 Year Treasury Bond Fund) by 2.3% for the quarter. (TIP returned 1.94% while IEF returned -.38%)

Nominal Treasurys pay a fixed rate of interest on a fixed amount of principal, so when inflation expectations change the market yield must adjust. TIPS have the inflation adjustment built in, so no repricing is needed.

Despite having similar durations, TIPS and Nominals provide exposure to different curves. While one is not inherently less risky than the other, inflation protection sure was nice to have this past quarter.

Have a great weekend.