TREASURY INFLATION PROTECTED SECURITIES (“TIPS”): REPLACING PANIC WITH CALM PERSPECTIVE

6/26/13

As anyone with a pulse who has been able to somehow tear himself or herself away from the “All Blackhawks, All the Time Because, After All, What Could Possibly Be Nearly As Important” coverage here in Chicago knows, bonds have taken a terrific beating of late.  Treasury Inflation Protected Securities (“TIPS”) of which I have been so enamored, and of which I own so many (as a proportion of our total holdings) have been beaten up at least as badly as conventional bonds.  

Some numbers can best convey the carnage in TIPS.   I am using the “closing” 10 year TIP yield (I had to be approximate for 12/10/12 and 6/24/13 on the yields; I’m an investor in TIPs, not a trader of TIPs, and so don’t necessarily follow the yield on a daily basis.) and the closing price of the exchange traded fund (“ETF”) TIP as indicators of levels:

Date                             10 Year TIP yield                     TIP Price

12/10/12 (High)            -1.00% (App)                          123.30

4/5/13 (2013 High)       -0.78%                                     122.57

6/24/13 (2013 Low)     0.60% (App)                            110.02

6/26/13 (Today)           0.54%                                      110.72

Note how tough the last few months have been.   Obviously, I had some doubts about my loyalty to TIPS, especially given the misgivings I expressed in my last post on TIPS, 2/2/13’s YES, I’M STILL HOLDING ONTO MY TIPS and the posts to which it referred my readers. 

But, as I indicated on 6/20/13 (INVESTORS:   HERE’S WHAT TO DO WHEN THERE’S NOWHERE TO GO or…GIMME THAT OLD TIME RELIGION), I have taken no action on my TIPS, or on any of my investment positions, in response to the market turmoil of the last several weeks.  Full disclosure, though…I do have a rebalancing date on Friday and may sell or buy TIPS as part of that rebalancing, but rebalancing has nothing to do with one’s perceptions of the market; it is, instead, the sine qua non of rational investing and must be done religiously regardless of one’s feelings about the market, as I have said and written ad nauseam in the past and will say and write until the day I die.

Besides my aversion to getting emotional and consequently doing dumb things in response to market gyrations, there is another reason I have done nothing on TIPS, or anything else in my portfolios, and do not, on reflection, feel bad about not lightening up on TIP position.  That reason is PERSPECTIVE.

Let’s use the price of the ETF TIP as a surrogate for TIP performance.  I purchased my largest TIP position in three bites…in June, 2004, July, 2005, and June, 2006, coinciding, not at all coincidentally, if you will, with one of my rebalance dates and with my gradualist approach to investing.  I have reinvested all interest payments or, technically, dividends since TIP is an exchange traded fund.   My average price on my TIP position is 104.738, which is, of course, inflated by the reinvestment of dividends at higher TIP prices.   Those 2004, 2005, and 2006 purchases were made at the prices of 102.44, 107.23, and 100.56, respectively.

As can be seen in the numerical array above, TIP closed today at 110.72, considerably above my average price and, more importantly, since these are bonds, I have been collecting, and reinvesting, interest payments along the way.   Further, when I bought those bonds, I didn’t have the expectation that TIP would trade as high as 123.30, at least not as quickly as it did; such price appreciation, when added to the dividends collected and reinvested, would result in an unusually high return a bond investment, or at least for a bond investment in which credit was and is not a consideration.  As loyal readers know, I knew at or about the time of the high that TIPS, like conventional bonds, had run too far, too fast, courtesy of the Fed, and real rates were bound to increase, bringing both conventionals and TIPS down.

So do I wish I had sold my TIPs at or near the high?  Of course, one always wishes one could sell at a high, but, perhaps strangely, I don’t feel bad that I didn’t sell 12 points or so higher. 

Am I crazy?  Why wouldn’t I have liked to have sold something around 123 that is currently trading at 110.72?  The answer is simple:  I am not smart enough to pick the high on anything.   Further, even assuming I got lucky and  picked and sold at the high, I am not smart enough to get back in at a decent entry point.  If I were so “smart” as to think I could trade TIPS, I might have gotten out at 110, a high price relative to my average cost, and gotten back in at 123 rather than the opposite.   So rather than try to do things that I am, and most people are, incapable of doing, I simply held my TIPS position.  In so doing, I have enjoyed a pretty decent return…judging from my 104.74 average price, the 110.72 average price, the coupons, if you will, that I have clipped and reinvested in the intervening years, and the inherent safety of a government issued bond with built-in inflation protection.

Further, at the prevailing yields of 2.54% on the conventional 10 year and 54 basis points (“bps”) on the 10 year TIP, the implied projected inflation rate is 2% for the next ten years.   A lot of people believe that inflation will average less than 2% over the last ten years.  I am not one of them.   On a relative basis, then, I would be a big buyer of TIPS at these levels…if I were inclined to be a trader of, rather than an investor in, TIPS.