|If tips are such a bad portfolio holding under deflation why have they done so well recently when the coming deflation is the new "market consensus" ?|
Earlier in the year with the conventional wisdom predicting inflation and higher interest rates many went 'all in" and positioned themselves aggressively to profit from higher interest rates. As the WSJ reports it didnt work out too well:
Betting against Treasury bonds was supposed to be the no-brainer strategy for 2010. Instead, shorting government debt has brought steep losses so far this year, due to surging bond prices as investors seek safety on worries that stocks could be hit by deflationary headwinds. The largest exchange-traded fund tracking the long end of the Treasury curve, the $3.3 billion iShares Barclays 20+ Year Treasury Bond Fund (trading symbol TLT), has rallied more than 10% year to date.Now that the conventional wisdom has done its 360 degree swing the crowd of advisors and advice givers is now positioning for the now "certain" deflation. Some of the advice risky, pushing portfolios into a position that will get burned badly if this "consensus forecast"(once again) proves icnorrect and (once again) the "no brainer" portfolio moves turn out(once gain) to be big losers. One interesting part of this poor portfolio advice is a simplistic evaluation of the role of tips in a portfolio anticipating deflation.
At the same time, a leveraged ETF designed to profit from falling Treasury prices, ProShares UltraShort 20+ Year Treasury (TBT), has lost more than a quarter of its value as yields have ticked steadily lower—bond prices and yields move in opposite directions.
From the wsj:(my bolds my comments in blue)
Strategies to protect your portfolio from—and take advantage of—the dreaded 'D' word.
Bond-fund manager Jeffrey Gundlach—who thinks yields on the 10-year Treasury note could fall to 2%—has about 40% of the DoubleLine Total Return Bond Fund's assets in longer-term government debt, such as Ginnie Mae securities. If yields on 10-year Treasurys fall to 2% within a year, investors could reap total returns of 10% to 12% as the price of the securities jump, he says.
Zero-coupon Treasury bonds, known as strips, can provide the best protection, since the fixed rates are locked in and automatically reinvested at the fixed rate, says Troy Von Haefen, a financial adviser in Nashville, Tenn., who primarily uses Treasury strips as a deflation hedge and holds them to maturity.
Conversely, inflation-linked securities such as TIPS (Treasury inflation-protected securities) and I Bonds (inflation-linked savings bonds) could lose value in a period of sustained deflation. When the consumer price index turned negative in 2009, for example, rates on I Bonds temporarily dropped to 0%. Investors could see the value of their TIPS decline, since any negative change in the CPI would be applied to TIPS' principal, reducing the interest earned. (If investors buy TIPS at auction and hold the bonds until maturity, the Treasury pays the inflation-adjusted principal or the original principal, whichever is greater.)
The price if a tips bond (and the tips etf) is reflective of the real yield on the tips in one's portfolio compared to the market real yield of tips.Price moves inversely to yield just like for regular bonds except for tips it is the real yield not the nominal yield that determines the price. When inflation expectations fall, real yields on the tips go down and the prices go up. The current real yield on the 10 year tip is around 1.1%. That explains the price appreciation in the tips etf in the chart below. The fact that i bond yields (not the same as ibonds btw since ibonds are not a tradeable instrument) went to 0% at one point is interesting but not particularly relevant. It also means that someone holding an inflation protected bond with a 1% real yield would reap a considerable capital gain in the unlikely event that tip yields hit zero.
Last month, Janet Briaud, a financial adviser in Bryan, Texas, sold her clients' holdings in TIPS, parked the proceeds in cash and has been putting as much as 20% of clients' money in long-term government bonds. "If markets come down over the next 18 months, we expect that investors will go to the safe haven of Treasury bonds," she says.
|Long term treasury etf (tlt) vs TIP etf (TIP)||P|
|intermediate term treas eft (ite) v tip|
An increase in inflation expectations will hit the tips holder less than the conventional bond holder. The tips holder gains on the deflationary expectations, is hurt less than the conventional bond holder when inflationary expectations go up and gets an increase in his cash flow should actual actual inflation occur (unlike of course the holder of conventional bonds). In effect the tips position has a "long inflation put".due to its inflation insurance feature as we know long options positions are effectively insurance.
safe haven of Treasury bonds,
with reference to tips and conventional treasuries of course that is a non issue the "safe haven" aspect refers to bond being backed by the full faith and credit of the us govt and of course both tips and convnetional treasury bonds are the same in this repspect.