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
- posted 8 years ago
-- David S. Meyers, CFP(R) http://www.MeyersMoney.com
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