ThelongandshortofTIPS-TheVanguardGroup.pdfVIP

The long and short of TIPS Vanguard research October 2012 Executive summary. Assets can be considered an “inflation hedge” if either their purchasing power is maintained over the long run or their Authors nominal returns closely track realized inflation over shorter horizons. Since Joseph Davis, Ph.D. the introduction of the U.S. Treasury Inflation Protected Securities (TIPS) Roger Aliaga-Díaz, Ph.D. market in 1997, broad-market TIPS returns have generally met both criteria. Charles J. Thomas, CFA That said, the aggregate U.S. TIPS market carries considerable interest Nathan Zahm, FSA rate risk, compared to shorter-maturity TIPS benchmarks. This paper compares the correlation of U.S. inflation with TIPS benchmarks in three distinct maturity buckets. We then compare their inflation-hedging properties to those of other asset classes. We found that the return on a short-term TIPS benchmark (of 0-to-5-year maturities) has been more highly correlated to actual monthly and yearly CPI (Consumer Price Index) inflation than other segments of the U.S. TIPS market over the past decade. Although, in practice, all TIPS securities Connect with Vanguard  receive the same CPI principal adjustment, short-term TIPS returns tend to most closely track actual CPI inflation because of their lower duration and greater responsiveness to temporary, unexpected inflation spikes. We found similar results for the United Kingdom’s inflation-linked gilt market, which has existed since 1981. Short-term TIPS returns have shown markedly lower volatility, yet a similar or higher inflation correlation, than that observed for certain “real assets” such as REITs, commodity futures, and gold. Our results imply that a short-term TIPS portfolio may be a more appropriate inflation-sensitive investment than the broad TIPS market for risk-averse