Inflation-Protected Bonds Fail a Key Test: They Don't Help When Inflation Is High

[question everything]

The bonds known as Treasury inflation-protected securities are designed to protect investors’ income against rising prices and perhaps even deliver an extra bit of return. But do TIPS, as the bonds are commonly known, live up to their promise?

Unlike other Treasury securities, where the principal is fixed, the principal of TIPS can go up or down over the bond’s term. When TIPS mature, if inflation has gone up over the life of the bond, the principal will scale with it and your payout at maturity is higher. TIPS also pay a coupon every six months until maturity that scales with inflation. Putting TIPS to the test over the past three decades of data, my research assistants (Maha Almoshaddak and Donovan Etienne) and I find that they don’t deliver when inflation is high. In fact, if you are jumping into TIPS when inflation is high, you have already missed the boat and likely will underperform.

(snip)

In 2021, when inflation was crawling higher (before the Fed responded with higher rates), only if an investor was able to get in early would there be any sort of positive return with TIPS. During 2021, the average TIPS investor saw a 4.81% return, beating the 1.25% return for the average fixed-income fund that year.

Yet if getting into TIPS in 2022 when inflation was hitting its maximum levels and the Fed was raising rates considerably, the average investor would have lost out dearly. During 2022, TIPS delivered an annualized return of negative 11.51%, doing worse than the average fixed-income fund, which delivered a return of negative 11.16% for the year.

These results highlight that there is no such thing as a free lunch in financial markets. One can’t get into TIPS after inflation has already skyrocketed and expect protection. Only if you are early to the game and see inflation ticking up before others do will you gain a little extra return by jumping into TIPS ahead of the rest of the market.

https://www.wsj.com/finance/investing/tips-inflation-ec5d8564?st=DLn4ue&reflink=desktopwebshare_permalink

free

[bucolic_frolic]

1. News to tuck away in the crevices of one's mind

Thanks

[lastlib]

2. It has been known for a long time that TIPS perform best.....

...when the *expectations* of inflation are higher than the *actual* inflation rate. It's also known that the TIPS principal adjustments don't always match up to the actual inflation rates. They do perform slightly better than standard Treasury bonds during inflationary times, but they don't really keep up with inflation.

I had to do similar analytics on these bonds when I worked in the investment field.