I've been thinking a lot lately about my positions in TIPs, and their place in a portfolio, and, of course, their current pricing level.
They are really purely an inflation hedge. At this point, with zero/negative interest rates, they are nothing at all more than a perfect hedge on CPI-U. They generate no income.
So when constructing a portfolio and including fixed-income exposure, there are generally two different reasons to include it. In a total-return view, they are there only partially for income/yield but very much more are there to provide asset-class diversification to provide uncorrelated returns against equity exposure. In that total-return context, the actual returns of the fixed income, and especially the cash-flow that it generates are less important than how they behave when stocks move one way or the other. This is generally a stronger argument for US Treasuries, even though they generally have lower yields than any other fixed income, they also have a lower correlation with equities and have had, especially through the last couple of disaster markets, great returns as yields have dropped through the floor.
The other place for fixed income is in a cash-flow/income oriented portfolio, where the bonds are there to generate a paycheck for the investor and the stocks are there to provide growth (and a smaller paycheck through dividends), especially over the longer-run and to overcome inflation. In this context, the correlations and even the potential for capital gains (ie. dropping interest rates) are less important than the dividends paid out.
So now where do TIPs fall in this? Clearly not in the latter income-oriented portfolio, since right now they don't generate any income at all.
But I'm also thinking that given the absurdly low yields of both TIPs and other Treasury bonds, maybe there's no place for either of them in either income or total-return portfolios. In essense, they don't fit into income due to the low to non-existent yields. But they may well not fit into a total return portfolio either given that the interest rates are at historic lows and seem unlikely to go down any more - so there really seems almost no potential at all for capital gains either - meaning that even if stocks drop again, I find it hard to believe that TIPs or Treasuries can perform the function that they are supposed to in a total return portfolio - they cannot zig *up* any more whether stocks go up or down. So even though I don't generally subscribe to market timing, can one justify keeping TIPs or any Treasuries in a portfolio right now?
Thoughts?