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Most TIPS now have negative yields

edited April 19 in Other Investing
https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=realyield

Good article in this weeks Barrons. Key take-away is that even with the inflation adjustment, most investors today are likely to lose money owning TIPS. Linked chart begins at 5 years. But apparently even shorter TIPS obligations (1-3 years) carry negative yields.

Anybody ever had their negative interest rate subtracted from a TIPS fund at the end of a month, quarter, year? Seems like that could happen ... I don’t pretend to understand them very well. Am dabbling a bit in TLDTX as a cash proxy and it’s slightly ahead YTD.


*From linked page

“Treasury Real Yield Curve Rates. These rates are commonly referred to as "Real Constant Maturity Treasury" rates, or R-CMTs. Real yields on Treasury Inflation Protected Securities (TIPS) at "constant maturity" are interpolated by the U.S. Treasury from Treasury's daily real yield curve. These real market yields are calculated from composites of secondary market quotations obtained by the Federal Reserve Bank of New York ...”

Comments

  • Interesting Interview on Inflation With Cullen Roche:


  • msf
    edited April 20
    "Anybody ever had their negative interest rate subtracted from a TIPS fund at the end of a month, quarter, year?"

    There's likely more wrapped up in that question than many realize. First a few basic attributes of TIPS: Even though TIPS are guaranteed to accumulate interest at a real rate of at least 1/8% (1/8% plus inflation adjustment), one can still buy TIPS yielding negative real rates. That's because TIPS can be sold above face value. For example, one might buy a 10 year TIPS at auction for $105. In 10 years, aside from inflation adjustments, it would pay 1.25% (10 x 0.125%) ignoring compounding but decline 5% in value - for a net negative real return.

    The key here is that the negative rates are YTM, not just interest. If a fund owned only the single TIPS described, its share price would decline over a decade from $105 to $101.25, ignoring tax quirks (more below). No magic, no interest subtracted.

    So far, I've been describing real rates and real returns. That's why I could simply disregard the inflation adjustment. It's that adjustment that "eliminates" the effect of inflation and leaves one with real rates. When we add in those adjustments, we usually get nominal rates that are positive.

    February's 12 month CPI increase was 1.7%, the March figure is 2.6%. Based on these figures, all TIPS currently have nominal positive yields. With that, most concerns about the mechanics of negative rates go away.

    Taxation of TIPS funds is where things get tricky. Even though TIPS don't pay out interest, they just accumulate it, the nominal interest is imputed. That means that somehow, a TIPS fund has to show that interest on your 1099-DIV. It does this by declaring dividends equal to the imputed interest. Remember, we're talking nominal interest, so this is generally a positive amount, even though the real return is negative.

    For investors who reinvest dividends, this is largely an exercise on paper. Like dividends of any fund, the share price of the fund drops when it goes ex-div, investors are credited with extra shares at the lower price, the IRS is happy, and no real money changes hands.

    For investors who take their dividends, the fund has to come up with real cash. That cash may come from dividends and interest of other securities, or in the case of a pure TIPS fund, the fund may have to sell off some securities to raise cash. Again, this is not really different from what any other fund does when it declares divs.

    The more interesting question, for which I still don't have an answer, is the one I think hank had in mind - what happens when the nominal, imputed interest is negative. That happens when the fixed rate (positive) plus a deflation adjustment comes out negative.

    For individual TIPS, you actually get to subtract that negative imputed interest from your income - but only to the extent that you'd previously imputed positive interest. (You get to carry over the remainder to use against future imputed interest.) See p. 3 of this paper on TIPS:
    https://www.wintrustwealth.com/sites/default/files/Wintrust Wealth Management/Treasury Inflation-Protected Securities_2018_0.pdf

    I have no idea what a fund is expected to report for negative imputed interest on your 1099, let alone what magic it could perform to create negative dividends.

    Correction TIPS do pay out their fixed rate amount, it is only the inflation adjustment that is accrued. The amount of fixed interest gradually increases, since is is based on a growing (in nominal terms) principal amount.
  • Thank you for the explanation on "negative yield" comment. It is confusing for many investors. For example, Vanguard inflation protection securities fund, VIPSX, is listed with SEC yield of -1.68% with a footnote (G)
    The yield quoted is the real yield, or the yield before adjusting for inflation. The actual yield on Vanguard Inflation-Protected Securities Fund will be a combination of the real yield and an inflation adjustment. A complete estimate of the fund's yield requires that an estimate of future inflation be added to the real yield. Because inflation fluctuates, it cannot be projected into the future precisely enough to be included in the yield quote. The inflation adjustment is based on changes to the Consumer Price Index (CPI) and can either be positive or negative, based on the change to the CPI. Investors interested in maintaining the purchasing power of their investment should reinvest their dividend distributions.
    Your explanation put more context on how TIPs work. Are you proposing that individual TIPs would be more appropriate for individual investors?
  • I don't have a strong preference one way of the other. As with other Treasuries, there's no need to hold several securities to diversify away credit risk. Other considerations strike me as minor and a matter of taste:

    With a fund, one pays for management but adds convenience.

    There's the usual bond vs. fund question of a bond having a known value at maturity (in real dollar terms here) vs. a fund's value fluctuating.

    What's distinctive about TIPS and TIPS funds is the handling of imputed interest. If you want a cash flow, then a fund may be better, since it converts imputed interest into real divs. This also addresses the phantom income issue of TIPS in a taxable account.
  • edited April 20
    @msf - You belong in the fixed income department at TRP or some other big player.:) Suspect your knowledge exceeds that of some who deal with these issues daily. Thanks. I’ll confess to a little “click-baiting” with my question about having negative interest subtracted from one’s TIPS fund. As you suggest, I think, it’s a possibility - though unlikely. More likely, I suspect, the “negative interest” might simply translate into a lower NAV. I wonder too whether some of the bigger players might “cover” negatively accrued interest should it be necessary in the same way they’ve propped up teetering money market funds in the past?

    The tax repercussions are fascinating. As I’m only using TIPS in a sheltered account, that’s not an issue for me. Like millions of others, I was drawn in the direction of TIPS earlier this year for the same reasons mentioned in the Barron’s excerpt below. Unlike some, I realized that not all TIPS are the same and that with longer dated TIPS there was a strong likelihood one could loose money as Treasury rates surged. Price’s longer duration TIPS fund, PRIPX, is off 0.61% YTD. Fortunately, the limited-term TIPS index fund I went with is slightly positive - but “nothing to write home about.” While on the subject, TLDTX carries a 0.22% ER, making it a decent choice for idle funds you don’t want to commit to equities or other riskier holdings.

    As the post has generated some interest among board members, I’m taking the liberty of quoting a longer (but abbreviated / edited) passage from the April 19 issue of Barrons :

    “Investors in search of ways to protect their income against inflation may need to look further than they think: The market created for that purpose may not be a great choice, for either income or returns ... Treasury inflation-protected securities, or TIPS, have attracted investor cash this year as investors bet that a mix of economic reopening and U.S. government stimulus will drive prices higher in the U.S. Funds investing in TIPS have seen 25 consecutive weeks of inflows from investors since October of last year ...

    “Their current yields should be a reason for caution among income investors in particular. At the moment, all TIPS maturities other than the 30-year offer negative yields. The 10-year TIPS note yields nearly minus 0.8%, the five-year note yields about minus 1.7%, and the two-year note yields minus 2.6% ... In theory, negative yields could translate into returns if inflation climbs persistently in coming years. But the trade isn’t a simple one. For it to pay off, there needs to be more inflation than the levels that are already priced into the market today.”


    https://www.barrons.com/articles/tips-for-investors-look-elsewhere-for-inflation-protection-51618572606

    Link may not work. Sometimes doing a search for the exact words in the excerpt will.

  • msf
    edited April 20
    " In theory, negative yields could translate into returns if inflation climbs persistently in coming years."

    Those negative real yields are still going to be negative. If inflation runs at 2% so you get 2% added to the value of your TIPS annually, you have a security that's grown an extra 2%/year in nominal terms, but 0% extra in real terms. Your real return is unchanged. Same at 5% or any inflation rate.

    TIPS "win" with higher inflation primarily in the sense that they protect you against loss of value due to inflation, while "regular" (nominal rate) Treasuries lose value faster and faster as inflation climbs.

    If inflation runs exactly as priced into the market, TIPS should slightly underperform "regular" Treasuries, since you're paying a little for that inflation insurance. If inflation runs higher than is priced into the market, you win, but only relative to the "regular" Treasuries.
    A concern arises, however, when the [regular Treasury bond] investment earns 4% and inflation is running at 3%. This means that the real rate of return – the stated return minus inflation – is only 1%. A bond investor locks in the money for a period of time and commits to a specific income stream, but if he underestimates inflation, future proceeds from his investment may have less purchasing power.

    Unlike nominal bonds, TIPS are designed to offer a real rate of return and, hence, provide investors a certain amount of protection against inflation. By investing in TIPS, investors give up the certainty of a predictable income stream for the assurance that their investment will maintain its purchasing power in case of rising inflation. For that assurance, TIPS pay slightly lower interest rates than comparable maturity Treasury securities.
    https://www.raymondjames.com/wealth-management/advice-products-and-services/investment-solutions/fixed-income/taxable-bonds/tips-treasury-inflation-protected-securities

    Again, the negative real rate comes from buying a bond for $105 that has a current face value of $100 and after a decade and inflation still has a real purchasing power of $100. The inflation adjustment protects against declining purchasing power of the $100; it doesn't protect against the $5 loss of value from buying at a premium.

  • edited April 20
    “If inflation runs exactly as priced into the market, TIPS should slightly underperform ‘regular’ Treasuries, since you're paying a little for that inflation insurance. If inflation runs higher than is priced into the market, you win, but only relative to the ‘regular’ Treasuries.”

    A great way of looking at it.
  • I own IVOL in a number of accounts, which ISTR is comprised of TIPS plus hedges for rising interest rates, so these discussions would probably apply to that etf as well.
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