Bond Mutual Funds are getting Killed

Jun 12, 2007 5:37 pm

I have clients holding funds that are down 10-15% from last week

what do I tell clients(besides that I was wrong)?

Jun 12, 2007 5:52 pm

I guess just tell them they still have their yield…

Jun 12, 2007 5:59 pm

What bond funds are you in? High Yield? Emerging Market? Mortgage backed?

My boy Dan Fuss at Loomis Sayles is down a little bit the past couple weeks- just convey to your clients that you have conviction in your strategy, are confident in your managers ability, and that this short term volatility is not only normal but has been expected...

Jun 12, 2007 6:04 pm

Ther where several articles out over the last couple of months about the high yield bubble! Low spread warnings!

So I switched all the high yield funds into Loomis Sayles no later then last month!

Jun 12, 2007 6:06 pm

That bond funds, just like individual bonds, fluctuate inversely with interest rates.  When rates go up the value of the bonds goes down. The bonds still pay the same coupon rate. 

In a bond fund, the fund manager will be able to add newer higher coupon bonds in the future which will help the overall portfolio. Unlike an individually held bond where the client either bites the bullet and holds to call, maturity or hopes for a reverse in interest rate trend.

If your clients are not using the income and they are reinvesting, they are buying more shares per dollar than when the share prices were higher.  Dollar cost averaging is a good thing when prices periodically (not permanently) decline.

That's really simplistic and there are a lot more factors, as BondGuy can surely tell us, depending on the duration of the bond portfolio, credit quality, leverage in the fund etc.

Don't say you were wrong. No one can predict the market and hopefully you explained that bond funds can fluctuate just as much as stock fund so your clients are prepared for this.

Jun 12, 2007 6:06 pm

im in muni's

Jun 12, 2007 7:01 pm

[quote=Vin Diesel]

im in muni’s

[/quote]

Tell them that a lower coupon rate leads to higher duration, and thus more interest rate sensitivity, given equal maturities. So if you reach for yield by going to the long end of the muni curve, expect some bounce.

I do hope that given the inverted Y/C (a highly unstable situation) you had clients mostly in very short duration instruments.

http://finance.yahoo.com/q/bc?t=3m&s=TLT&l=on&z= m&q=l&c=SHY%2CTLH%2CIEF

So here we see what happens to 1-3, 7-10, 10-20, and 20+ Tbonds as the yield curve steepen via long rates rising.

I’d tell clients, that the bond funds are currently bouncey as a result of the yield curve instability. Over time the funds should recover as bond portfolio’s roll over.
Jun 12, 2007 7:03 pm

Tax free + tax Loss make Vin Diesel look like a investment GENIUS!

"Mr. Jones, let's sell this open end fund that is trading at it's nav and buy that closed end fund that is trading at a discount to it's nav! This way we can replace the income and when the pressure comes off the bonds this fund will revert back to trading a a premium. Meanwhile we've been able to stick uncle with our loss against all those gains I've made for you and $3,000 against ordinary income for as long as it lasts!"

Huh? What's that? You bought them in an IRA? (just kidding)

Jun 12, 2007 7:07 pm

"But Vin, if I sell the bond fund now at a loss and I buy discounted CEFs that I'll sell later at a gain...Won't I be paying tax on those gains?"

"EYYYYYY! Mr Jones! Whattmatterforyou? I'm Vin Diesel! I'll have losses for you by the time we take dose profits! Bet on it!"

Jun 12, 2007 7:13 pm

[quote=Dust Bunny]

Don’t say you were wrong. No one can predict the market and hopefully you explained that bond funds can fluctuate just as much as stock fund so your clients are prepared for this.

[/quote]

For our company, we are basicly positioned with a core TIPS allocation, and remainder is in very Short treasury

Right now I am avoiding latent credit risk in bond portfolios, and in positioned for higher rates. I see  two sources for this,  organic steepening  of the Y/C at the long end and widening credit spreads.

http://www.bmonesbittburns.com/economics/focus/20070608/feat ure.pdf
Jun 12, 2007 7:25 pm

Ther where several articles out over the last couple of months about the high yield bubble! Low spread warnings!

So I switched all the high yield funds into Loomis Sayles no later then last month!

I would take my boy Fuss Face over any bond manager out there....

Jun 12, 2007 7:34 pm

For our company, we are basicly positioned with a core TIPS allocation, and remainder is in very Short treasury

Me too.  I also like some of the CPI linked bonds with shorter durations and the death put.

**in case you guys wonder why I'm posting so much during biz hours, I'm home sick

Jun 12, 2007 7:38 pm

[quote=Dust Bunny]

For our company, we are basicly positioned with a core TIPS allocation, and remainder is in very Short treasury

Me too.  I also like some of the CPI linked bonds with shorter durations and the death put.

**in case you guys wonder why I'm posting so much during biz hours, I'm home sick

[/quote]

If you don't mind the bounce, then TIPS are the place to be.

When I build portfolios I tend to go along the lines of

TIPS --> REITs --> Dividend Stocks --> General Market.

A risk spectrum of investments that benefit from inflation. Long muni's are damn near the worst place to be in an environment of increasing inflation and interest rates.
Jun 12, 2007 7:48 pm

I’m sorry, my clients don’t buy long term muni’s or bonds to sell on the market later on.  If you are in the top 2 tax brackets, this is a great time to buy and own long term muni’s IF they are part of your ladder.  I would encourage high net worth clients to start buying last weeks issues that are still outstanding.  For them, it means getting a discount on some nice AAA rated, 7% TEY muni’s that are LESS likely to be called early.  I don’t want to sell 8% to people because the people you sell munis to are not going to want them to be called nor are they going to want to sell them on the market.  Who do you people sell muni’s to anyway?  I also find much less value in bond funds because this type of panic that occurs.  If you are worried about losing value on fixed investments, then buy CMO’s.  You can at least get your principal back when rates change. 

Jun 12, 2007 7:50 pm

[quote=AllREIT]

If you don't mind the bounce, then TIPS are the place to be.

When I build portfolios I tend to go along the lines of

TIPS --> REITs --> Dividend Stocks --> General Market.


[/quote]

Call me a "unsophisticated" adviser if you want, but you are building portfolios around TIPS???  With yields less than 3% (not including the management fee), who on earth is dumb enough to invest their money with you?  I can use the freaking MONEY MARKET within our brokerage accounts and earn 4.39% for the clients and not charge them a fee to do so.

Jun 12, 2007 7:51 pm

By the way, I have been using the ING Senior Income Fund for awhile now, and it has not been “killed” at all.

Jun 12, 2007 7:58 pm

Yeah, damn near it... Unless they need to raise tax rate to pay for the higher interest costs and inflated cost of running a government. How do higher tax rates figure into your limited universe?

Short term treasuries are damn near the worst place to be in an environment of increasing inflation (at least in this cycle of increased inflation) STTs were paying less than 2% pre tax (so call it 1.33 after tax) meanwhile commodity prices more than doubled in the past 5 years.  At 1.33% it'll take 54 years for your money to double.

Keep in mind that we had increased inflation for far longer then we've had increased interest rates. meanwhile, the true rate of inflation has been dramatically higher than the CPI, we all know that to be true. You're getting royally screwed on the TIPS when it comes to actual, real world purchasing power.

So maybe yours isn't the advice anybody ought to take for serious. 

The only bubble you should be worried about is the one you live in.

Jun 12, 2007 7:59 pm

Those floating rate funds scare me and for some reason I think they’re a time bomb.

Jun 12, 2007 8:07 pm

[quote=Mike Damone]Those floating rate funds scare me and for some reason I think they're a time bomb.[/quote]

Probably because they were at the heart of the derivative disaster of the mid '90s.

Franklin came out with the Adjustable Rate Mortgage fund and it was bank qualified so it sucked up huge money. Then Louie Ranieri came out with his Adjustable Rate Mortuary fund and crammed it chock full of IO's and PO's and inverse floaters and all of the other subatomic particles that come out when you split a mortgage.

Who Knew?   Ka.........    BOOM!

Jun 12, 2007 8:34 pm

[quote=BankFC]By the way, I have been using the ING Senior Income Fund for awhile now, and it has not been “killed” at all.[/quote]

That would be because it’s not terribly interest-rate sensitive by nature of the adjustable rate loans.  The NAV should hold up relatively well when rates are moving up.  Of course, it won’t appreciate(much) when rates move down, either.

Your primary vulnerability in that fund is credit risk.  Unfortunately those sorts of problems tend to happen pretty quickly and are driven by unexpected events.  So, if something does happen the damage will already likely be done by the time you read about it in the newspaper.

Jun 12, 2007 8:35 pm

[quote=BankFC]

[quote=AllREIT]

If you don’t mind the bounce, then TIPS are the place to be.

When I build portfolios I tend to go along the lines of

TIPS --> REITs --> Dividend Stocks --> General Market.

[/quote]

Call me a "unsophisticated" adviser if you want, but you are building portfolios around TIPS???  With yields less than 3% (not including the management fee), who on earth is dumb enough to invest their money with you?  I can use the freaking MONEY MARKET within our brokerage accounts and earn 4.39% for the clients and not charge them a fee to do so.[/quote]

Don't worry, you are unsophisticated.

Of course TIPS are the baseline asset, as they should be. They are the only sure thing real return asset.

But they don't generate most of the final portfolio's income or return which comes from mainly from the REITs and dividend stocks etc. The total blended portfolio's have yields ranging 5% to about 9%.

The main question currently, has been should people own cash vs TIPS  given the imputed real return on cash vs TIPS. Right now my thinking is that TIPS are insanely cheap relative to nominal bonds.



Jun 12, 2007 8:40 pm

[quote=Vin Diesel]

I have clients holding funds that are down 10-15% from last week

what do I tell clients(besides that I was wrong)?

[/quote]

Wrong about what?

Umm, what funds are off by that amount? We have major positions in 4 high yield funds. The worst is off by about 2% from it's yearly high and about 1.8% from a week or so ago, and it's still trading above where it started the year. The others down less than 1%. Hardly a burst bubble and nothing to worry about. Especially considering their near term performance.

Jun 12, 2007 8:42 pm

[quote=BankFC]By the way, I have been using the ING Senior Income Fund for awhile now, and it has not been “killed” at all.[/quote]

Well of course, that ING fund’s duration is going to be very close to zero, and thus current value is unaffected by interest rate movements. OTH declinging interest rates will lower the funds yeilds, while rising interest rates will squeeze the obligors.

But, go look up the credit ratings and then see if you still like it. I find it fascinating that ING does not disclose a weighted average credit rating for the fund. Try logging into Moody’s and run a few names

I’m reminded of what Seth Klarman said about Junk Bank loans,

“The bank’s may be senior, but everyone’s at risk”

Jun 12, 2007 8:52 pm

[quote=Whomitmayconcer]

Who Knew?   Ka…    BOOM!

[/quote]

That’s just because Lew Ranieri and crew sold all those those CMO’s to people who would look only at the term sheet, and not the prospectus.

Alot of fixed income managers didn’t have a chance as they had never delt with bonds with complex embedded options.

Remarkably similar to people buying ABS today…

Bond portfolio managers were not used to the strong negative convexity of residential mortgages.

They also didn’t have clue with things like PO’s which have a duration greater than Zero Coupon bonds, and IO’s which have negative duration (e.g value goes up when interest rates go up) but are deathly sensitive to prepayment rates etc etc.

It was a fun time.


Jun 12, 2007 9:09 pm

[quote=AllREIT]
For our company, we are basicly positioned with a core TIPS allocation, and remainder is in very Short treasury...[/quote]

"WE"? 

Jun 12, 2007 9:11 pm

[quote=mikebutler222]

[quote=AllREIT]
For our company, we are basicly positioned with a core TIPS allocation, and remainder is in very Short treasury…[/quote]

“WE”? 

[/quote]

Yep we have four people in our company, small office but growing.
Jun 12, 2007 9:12 pm

Bond funds? Who owns bond funds?

Jun 12, 2007 9:13 pm

[quote=AllREIT]
But they don't generate most of the final portfolio's income or return which comes from mainly from the REITs and dividend stocks etc. The total blended portfolio's have yields ranging 5% to about 9%.


[/quote]

More like 3.5% to 4.25% if you're using Tips in the manner you claim and counting on REITs and equity dividends for the yeild bump.

Jun 12, 2007 9:15 pm

[quote=AllREIT] [quote=mikebutler222]

[quote=AllREIT]
For our company, we are basicly positioned with a core TIPS allocation, and remainder is in very Short treasury...[/quote]

"WE"? 

[/quote]

Yep we have four people in our company, small office but growing.
[/quote]

Ok, how about a count not including the two guys filling the vending machine and the guy who stopped in looking for the Subway....

Jun 12, 2007 9:16 pm

[quote=mikebutler222]

Bond funds? Who owns bond funds?

[/quote]

Some of my clients do.  I figure the fund managers can choose individual bonds better than me.

Jun 12, 2007 9:18 pm

[quote=mikebutler222][quote=AllREIT] [quote=mikebutler222]

[quote=AllREIT]
For our company, we are basicly positioned with a core TIPS allocation, and remainder is in very Short treasury...[/quote]

"WE"? 

[/quote]

Yep we have four people in our company, small office but growing.
[/quote]

Ok, how about a count not including the two guys filling the vending machine and the guy who stopped in looking for the Subway....

[/quote]

Wow, you can actually be funny. 

Jun 12, 2007 9:36 pm

[quote=mikebutler222]

More like 3.5% to 4.25% if you're using Tips in the manner you claim and counting on REITs and equity dividends for the yeild bump.

[/quote]

That would really depend on what REITs/stocks and how much is allocated to them. Be very careful about assumptions.

Jun 13, 2007 1:05 am

[quote=AllREIT][quote=mikebutler222]

More like 3.5% to 4.25% if you're using Tips in the manner you claim and counting on REITs and equity dividends for the yeild bump.

[/quote]

That would really depend on what REITs/stocks and how much is allocated to them. Be very careful about assumptions.

[/quote]

The fixed income part of your portfolio, what should be the majority creator of yield, is plugged with your low yielding TIPs. To overcome that and produce the kind of portfolio yield you claim you'd have to grossly overweight REITs and dividend paying stocks.

ALLREIT, just a hint, but not everyone here entered the biz yesterday. Many of us can sniff out BS easily.

Jun 13, 2007 1:11 am

[quote=BondGuy][quote=Vin Diesel]

I have clients holding funds that are down 10-15% from last week

what do I tell clients(besides that I was wrong)?

[/quote]

Wrong about what?

Umm, what funds are off by that amount? We have major positions in 4 high yield funds. The worst is off by about 2% from it's yearly high and about 1.8% from a week or so ago, and it's still trading above where it started the year. The others down less than 1%. Hardly a burst bubble and nothing to worry about. Especially considering their near term performance.

[/quote]

Hey BG....how much you want to bet this guy is loaded up on relatively new high yield CLOSED END funds....?
Jun 13, 2007 1:12 am
mikebutler222:

Bond funds? Who owns bond funds?




ME! And all of my clients. I'm going golfing tomorrow w/ a client who absolutely refused to position ANYTHING in a fund that said 'bond' on it. I'm gonna get hell.
Jun 13, 2007 2:16 am

[quote=Ashland] [quote=mikebutler222]

Bond funds? Who owns bond funds?

[/quote]


ME! And all of my clients. I'm going golfing tomorrow w/ a client who absolutely refused to position ANYTHING in a fund that said 'bond' on it. I'm gonna get hell.[/quote]

 Sorry to hear that..

Jun 13, 2007 4:29 am

[quote=mikebutler222][quote=AllREIT][quote=mikebutler222]

More like 3.5% to 4.25% if you're using Tips in the manner you claim and counting on REITs and equity dividends for the yeild bump.

[/quote]

That would really depend on what REITs/stocks and how much is allocated to them. Be very careful about assumptions.

[/quote]

The fixed income part of your portfolio, what should be the majority creator of yield, is plugged with your low yielding TIPs. To overcome that and produce the kind of portfolio yield you claim you'd have to grossly overweight REITs and dividend paying stocks.

ALLREIT, just a hint, but not everyone here entered the biz yesterday. Many of us can sniff out BS easily. [/quote]


Why should the fixed income portion of a portfolio be the main source of yeild? Fixed income is about safety of principal and the interest payments based on it. If you want more than the risk free rate, you either take on large amounts of duration or credit risk.

I'd never send a bond out to do a man's job.

So indeed I expect the equity/hybrid portion of the portfolio to generate most of the income and most importantly to grow that income at a rate faster than inflation.

If the income isn't growing at/faster than inflation, you are losing purchasing power. So the core TIPS grow at the rate of inflation, and REITs/Dividend stocks hopefully grow faster.

Investing for absolute real returns is very different than investing with the hope of beating (not trailing too much) some market benchmark that is not relavent to the clients goals.
 
Jun 13, 2007 4:34 am

[quote=Ashland]ME! And all of my clients. I’m going golfing tomorrow
w/ a client who absolutely refused to position ANYTHING in a fund that
said ‘bond’ on it. I’m gonna get hell.[/quote]



Welcome to interest rate risk.



What I’d do is talk about the role of bonds in a portfolio and how
interest rate risk (which is the main risk of bonds) is only weakly related to equities.



Read this, and you should have plenty of things to say.



http://www.pimco.com/LeftNav/Viewpoints/2006/Role+of+Bonds+6 -2006.htm



And most importantly you should listen, let him vent out, and then
explain that part of having an advisor, is having someone who tells you
to do the right thing even if you don’t want to hear it.


Jun 13, 2007 5:56 pm

[quote=AllREIT] [quote=mikebutler222][quote=AllREIT][quote=mikebutler222]

More like 3.5% to 4.25% if you're using Tips in the manner you claim and counting on REITs and equity dividends for the yeild bump.

[/quote]

That would really depend on what REITs/stocks and how much is allocated to them. Be very careful about assumptions.

[/quote]

The fixed income part of your portfolio, what should be the majority creator of yield, is plugged with your low yielding TIPs. To overcome that and produce the kind of portfolio yield you claim you'd have to grossly overweight REITs and dividend paying stocks.

ALLREIT, just a hint, but not everyone here entered the biz yesterday. Many of us can sniff out BS easily. [/quote]


Why should the fixed income portion of a portfolio be the main source of yeild? Fixed income is about safety of principal and the interest payments based on it. If you want more than the risk free rate, you either take on large amounts of duration or credit risk.

I'd never send a bond out to do a man's job.

So indeed I expect the equity/hybrid portion of the portfolio to generate most of the income and most importantly to grow that income at a rate faster than inflation.

If the income isn't growing at/faster than inflation, you are losing purchasing power. So the core TIPS grow at the rate of inflation, and REITs/Dividend stocks hopefully grow faster.

Investing for absolute real returns is very different than investing with the hope of beating (not trailing too much) some market benchmark that is not relavent to the clients goals.
 [/quote]

You are so full of yourself and so in love with hearing yourself talk (or type, as the case may be) that you cannot stand the fact that REAL PROFESSIONALS on this board have called you out on your BS.

Risk free rate?  The risk free rate is far above what your sorry TIPS are generating.  One year and less CD's are paying north of 5%. Agencies, which are IMPLICITLY backed by the fed gov't are also in the mid 5%, and as I said before, even our FDIC INSURED MONEY MARKET is paying 4.39%.

In a million dollar portfolio, with a 50/50 equity/debt split, you are costing your clients over 200 bps on $500,000 =  $10,000 a year!!!

Not to mention your fee for such good advice...

Jun 13, 2007 6:20 pm

"I'm going golfing tomorrow w/ a client who absolutely refused to position ANYTHING in a fund that said 'bond' on it. I'm gonna get hell."

If that is the case, why does he have a bond fund?

Hell? You'll be lucky if all you get is hell. You ought to get an acat form. Hopefully you won't have a mark on your U4.

There are so many ways to skin a cat, why would you go putting a client who doesn't want to be, into a bond fund?

Because it's easier than seeking out alternatives.

You could have suggested that your client purchase an Adjustable rate preferred share (like the one that is trading at 42, has a 1.79 dividend which is a rate of 3.58% based on the $50 par value which is based on the constant maturity rate of the five year treasury, the one that resets in January of 2010) but I'm not naming names!

Don't mean to be mean, but, LEARN!

Jun 13, 2007 6:34 pm

[quote=AllREIT]

Why should the fixed income portion of a portfolio be the main source of yeild?  [/quote]

Sorry, the idiot alarms going off as a result of that statement make continuing this with you more trouble than it's worth. That comment is suitable for framing....

Clearly you're out of your depths here. You regurgitate the doctrine fed to you well, but where that doctrine fades you make a habit of saying absolutely foolish this that expose you as a neophyte in this business. The three ETF complete portfolio theory of your was just the first hint, many, many have followed. I think the forum members who have exchanged emails with me guessing that you’re some sort of a minor league academic that fancies himself an investment advisor and has less than 10MM in AUM have the story right.

Jun 13, 2007 11:08 pm

[quote=joedabrkr] [quote=BondGuy][quote=Vin Diesel]

I have clients holding funds that are down 10-15% from last week

what do I tell clients(besides that I was wrong)?

[/quote]

Wrong about what?

Umm, what funds are off by that amount? We have major positions in 4 high yield funds. The worst is off by about 2% from it's yearly high and about 1.8% from a week or so ago, and it's still trading above where it started the year. The others down less than 1%. Hardly a burst bubble and nothing to worry about. Especially considering their near term performance.

[/quote]

Hey BG....how much you want to bet this guy is loaded up on relatively new high yield CLOSED END funds....?
[/quote]

Maybe. Are they down big? I'm still trying to figure it out.

Anyway, staying to course.

Don't predict anything. Just buy bonds.

Jun 14, 2007 2:16 am

[quote=BankFC]Risk free rate?  The risk free rate is far above what your sorry TIPS are generating.  One year and less CD's are paying north of 5%. Agencies, which are IMPLICITLY backed by the fed gov't are also in the mid 5%, and as I said before, even our FDIC INSURED MONEY MARKET is paying 4.39%.[QUOTE]


Which is all jim dandy, except for the question of what is real risk free rate?

5.14 (10y CMT) - 2.72 (10y CMT TIPS) == 2.42% BIR<br>

That's the current market expectation for annualised CPI inflation over the next ten years. That spread (break even inflation) has to be applied against the treasury real curve to get the treasury nominal curve.

So after you take that 2.42% out, how much are those bank CD's etc really paying? That's the real question.

After you knock out expected inflation, the short end of the Y/C is the place to be. Hence I've positioned portfolio's to have both TIPS and short treasuries. This is what pretty much every TIPS manager is doing, since the value was in the short end of the curve.  E.g same real rate, lower duration.

Either way your not going to get huge real returns from fixed income unless you make big bets on duration or credit risk. So as I've explained elsewhere that's why recomend owning lots of NNN real estate and other hard assets whose value/income can grow with inflation.

The rent roll/escalation clauses provide real return, and there is built in arbitrage between fixed rate debt and the floating rents/tolls .

My goal is to match clients CPI-linked liabilities (e.g living expenses) with CPI-linked assets (TIPS/REITs/MLPs/Dividend Stocks etc). Now some people, myself included , think this is a sound way to invest for the long term.

Jun 14, 2007 2:29 am

[quote=BondGuy] [quote=joedabrkr] [quote=BondGuy][quote=Vin

Diesel]

I have clients holding funds that are down 10-15% from last week[/

P]

what do I tell clients(besides that I was wrong)?



[/quote]



Wrong about what?



Umm, what funds are off by that amount? We have major positions in 4

high yield funds. The worst is off by about 2% from it’s yearly high and

about 1.8% from a week or so ago, and it’s still trading above where it

started the year. The others down less than 1%. Hardly a burst bubble and

nothing to worry about. Especially considering their near term

performance.









[/quote]Hey BG…how much you want to bet this guy is loaded up on

relatively new high yield CLOSED END funds…?[/quote]



Maybe. Are they down big? I’m still trying to figure it out.



Anyway, staying to course.



Don’t predict anything. Just buy bonds.

[/quote]



Buy bonds, huh?



Well, today was a good day for it. We picked up some bargains.



Oh and by the way…you’re quite right. Don’t predict anything. Is te Fed

going to raise? Will China dump Treasuries on the markets? Who knows?

Who cares? Iff that’s the driving force for your clients, tell them to just go

to Atlantic City.
Jun 14, 2007 1:36 pm

[quote=AllREIT]

[quote=BankFC]Risk free rate?  The risk free rate is far above what your sorry TIPS are generating.  One year and less CD's are paying north of 5%. Agencies, which are IMPLICITLY backed by the fed gov't are also in the mid 5%, and as I said before, even our FDIC INSURED MONEY MARKET is paying 4.39%.[QUOTE]


Which is all jim dandy, except for the question of what is real risk free rate?

5.14 (10y CMT) - 2.72 (10y CMT TIPS) == 2.42% BIR

That's the current market expectation for annualised CPI inflation over the next ten years. That spread (break even inflation) has to be applied against the treasury real curve to get the treasury nominal curve.

So after you take that 2.42% out, how much are those bank CD's etc really paying? That's the real question.

After you knock out expected inflation, the short end of the Y/C is the place to be. Hence I've positioned portfolio's to have both TIPS and short treasuries. This is what pretty much every TIPS manager is doing, since the value was in the short end of the curve.  E.g same real rate, lower duration.

Either way your not going to get huge real returns from fixed income unless you make big bets on duration or credit risk. So as I've explained elsewhere that's why recomend owning lots of NNN real estate and other hard assets whose value/income can grow with inflation.

The rent roll/escalation clauses provide real return, and there is built in arbitrage between fixed rate debt and the floating rents/tolls .

My goal is to match clients CPI-linked liabilities (e.g living expenses) with CPI-linked assets (TIPS/REITs/MLPs/Dividend Stocks etc). Now some people, myself included , think this is a sound way to invest for the long term.

[/quote]

Is this the language you use to present this to clients?

Jun 14, 2007 1:56 pm

[quote=AllREIT]

[quote=BankFC]Risk free rate?  The risk free rate is far above what your sorry TIPS are generating.  One year and less CD's are paying north of 5%. Agencies, which are IMPLICITLY backed by the fed gov't are also in the mid 5%, and as I said before, even our FDIC INSURED MONEY MARKET is paying 4.39%.[QUOTE]


Which is all jim dandy, except for the question of what is real risk free rate?

5.14 (10y CMT) - 2.72 (10y CMT TIPS) == 2.42% BIR

That's the current market expectation for annualised CPI inflation over the next ten years. That spread (break even inflation) has to be applied against the treasury real curve to get the treasury nominal curve.

So after you take that 2.42% out, how much are those bank CD's etc really paying? That's the real question.

After you knock out expected inflation, the short end of the Y/C is the place to be. Hence I've positioned portfolio's to have both TIPS and short treasuries. This is what pretty much every TIPS manager is doing, since the value was in the short end of the curve.  E.g same real rate, lower duration.

Either way your not going to get huge real returns from fixed income unless you make big bets on duration or credit risk. So as I've explained elsewhere that's why recomend owning lots of NNN real estate and other hard assets whose value/income can grow with inflation.

The rent roll/escalation clauses provide real return, and there is built in arbitrage between fixed rate debt and the floating rents/tolls .

My goal is to match clients CPI-linked liabilities (e.g living expenses) with CPI-linked assets (TIPS/REITs/MLPs/Dividend Stocks etc). Now some people, myself included , think this is a sound way to invest for the long term.

[/quote]

You are ridiculous.  I agree with Mike, I am certain now that you are not an adviser, but rather an academic with an inflated ego from bullying college feshmen around and no real productivity other than your useless drivel.

I don't care what equations you use, but you'll never convince me or one of my million dollar clients why, for their short term fixed income investing, they are better off making 3% than 5%.

Jun 14, 2007 2:02 pm

You are ridiculous.  I agree with Mike, I am certain now that you are not an adviser, but rather an academic with an inflated ego from bullying college feshmen around and no real productivity other than your useless drivel.

I don't care what equations you use, but you'll never convince me or one of my million dollar clients why, for their short term fixed income investing, they are better off making 3% than 5%.

I had decided he didn't know how to sell to clients and was a money manager with no contact with the public.  All theory and no personal skills, but now I believe you guys are correct.

Jun 14, 2007 3:13 pm

[quote=BankFC][quote=AllREIT]

[quote=BankFC]Risk free rate?  The risk free rate is far above what your sorry TIPS are generating.  One year and less CD's are paying north of 5%. Agencies, which are IMPLICITLY backed by the fed gov't are also in the mid 5%, and as I said before, even our FDIC INSURED MONEY MARKET is paying 4.39%.[QUOTE]


Which is all jim dandy, except for the question of what is real risk free rate?

5.14 (10y CMT) - 2.72 (10y CMT TIPS) == 2.42% BIR

That's the current market expectation for annualised CPI inflation over the next ten years. That spread (break even inflation) has to be applied against the treasury real curve to get the treasury nominal curve.

So after you take that 2.42% out, how much are those bank CD's etc really paying? That's the real question.

After you knock out expected inflation, the short end of the Y/C is the place to be. Hence I've positioned portfolio's to have both TIPS and short treasuries. This is what pretty much every TIPS manager is doing, since the value was in the short end of the curve.  E.g same real rate, lower duration.

Either way your not going to get huge real returns from fixed income unless you make big bets on duration or credit risk. So as I've explained elsewhere that's why recomend owning lots of NNN real estate and other hard assets whose value/income can grow with inflation.

The rent roll/escalation clauses provide real return, and there is built in arbitrage between fixed rate debt and the floating rents/tolls .

My goal is to match clients CPI-linked liabilities (e.g living expenses) with CPI-linked assets (TIPS/REITs/MLPs/Dividend Stocks etc). Now some people, myself included , think this is a sound way to invest for the long term.

[/quote]

You are ridiculous.  I agree with Mike, I am certain now that you are not an adviser, but rather an academic with an inflated ego from bullying college feshmen around and no real productivity other than your useless drivel.

I don't care what equations you use, but you'll never convince me or one of my million dollar clients why, for their short term fixed income investing, they are better off making 3% than 5%.

[/quote]

They get 3% COUPON PLUS adjustments for inflation.

Frankly some of what ALLREIT is saying about funding cost of living expenses with growing income streams makes some sense to me.

But you can't talk to clients with that kind of language or they'll never get it.
Jun 14, 2007 5:09 pm

I take no issue with allocating X amount of dollars to risk free investments to cover someone's monthly nut.  That would be a prudent decision.

However, I've looked into TIPS in the past as well as recently, and I must say, I'd rather get a 5.25% coupon and my money back 9 months later to reinvest (ala a CD) than buy TIPS with a 2.85% to 3% coupon and some type of adjustment.

And again, you can't work for free selling TIPS, so there has to be an adjustment for management fees.  Often times, I'll have the customer open up a bankside CD (especially recently during this inverted yield curve) for the fixed portion of their money.  I don't particularly like dealing with bonds, although I do sell them periodically.

The point is ALLREIT is obviously not a retail adviser.  So I would urge all of you to take that in consideration and not get awed by his silly equations like he would have you do.

Jun 14, 2007 5:34 pm

http://www.bls.gov/news.release/cpi.t01.htm

"My goal is to match clients CPI-linked liabilities (e.g living expenses) with CPI-linked assets" AllReit

Allreit,

The above link is to the CPI data.

The point that i"d make to you from it is that the everyday living expenses have gone up dramatically higher than the overall CPI rate.

Water and sewer and trash collection        &n bsp;         &n bsp;         &n bsp;         &n bsp;         &n bsp;         &n bsp;         &n bsp;         &n bsp;
        services (2)..........................     & nbsp; .897    141.806    142.184     5.0     0.3     0.5     0.3     0.3
 {bolded is rate of increase YOY) 5% while overall CPI grew at 2.6%

Look at food, only Other and Dairy are below the overall rate of inflation.

Does it really help anyone that the drop in the prices of used cars (down 4.3%) is curbing the inflation index?

Pegging return to inflation as judged by the CPI is a sure path to the cat food aisle!, if this isn't true then how can it be that Seniors depending on SS with a CPI based COLA are the ones getting less and less by  on less and less?

Jun 14, 2007 6:17 pm

[quote=BondGuy][quote=Vin Diesel]

I have clients holding funds that are down 10-15% from last week

what do I tell clients(besides that I was wrong)?

[/quote]

Wrong about what?

Umm, what funds are off by that amount? We have major positions in 4 high yield funds. The worst is off by about 2% from it's yearly high and about 1.8% from a week or so ago, and it's still trading above where it started the year. The others down less than 1%. Hardly a burst bubble and nothing to worry about. Especially considering their near term performance.

[/quote]
Jun 14, 2007 6:22 pm

Oops, sorry about blank post above. 

My intended comment was that I had a "holy crap" moment when I saw the initial post about bond funds being down 10-15%, and immediately logged off of here to check how my badly my bond funds had dropped the past few weeks.  I knew they would be off some, but I had no idea it had gotten that bad without me realizing it. 

Bottom line:  my top bond fund holdings were down about 1%.

By the way, if we are in a theatre and you ever shout "fire", don't expect me to be running for the door.

Jun 14, 2007 6:27 pm

[quote=Whomitmayconcer]

http://www.bls.gov/news.release/cpi.t01.htm

"My goal is to match clients CPI-linked liabilities (e.g living expenses) with CPI-linked assets" AllReit

Allreit,

The above link is to the CPI data.

The point that i"d make to you from it is that the everyday living expenses have gone up dramatically higher than the overall CPI rate.

[/quote]

CPI is our best guess as to what inflation really is. However the food/energy component of it are very bouncy. Eventually higher costs for food/fuel get reflected elsewhere in CPI.

Right now the food cost index is getting fluffed by higher fuel costs (it takes alot of energy to move food around) and the effects of corn being diverted away from food use into fuel. There is also some talk that the food companies are using this as an excuse to ratchet prices.

So, thats one reason why you seek a margin of safety by investing in companies who's dividend CAGR is higher than CPI.

Jun 14, 2007 6:34 pm

So ALLREIT, are you an associate professor of finance at a top tier community college or a mid tier state university...

Inquiring minds want to know.

Jun 14, 2007 6:42 pm

Community college finance teacher is my guess.

Jun 14, 2007 6:45 pm

[quote=BondGuy]

Is this the language you use to present this to clients?

[/quote]

Depends which clients.

Everyone gets the basic idea of inflation erodding purchasing power.

I like to tell a story of Rip van Winkle who fell asleep in 1975 with enough  bonds to buy a new caddilac and but then couldn't buy new caddilac in 2005 when he woke up.

Now had he fallen asleep with enough TIPS to buy a new caddilac, he'd have been in good shape, since the value of capital was preserved via the inflation accretions.

And then you explain who you can substitue a peice of real estate, an oil pipeline, etc for the TIPS.

When selling TIPS, the main thing you have to do is bridge the preception gap between the equal real yield of nominal vs real bonds and the unequal nominal yeild.

So for BankFC's argument about CD rates.

A one year TIPS @ 2.5% + 2.5% CPI and one year CD @ 5% have the same total return, since the TIP's par value goes from 1000 to 1025, and it pays $25, while the CD's par is constant and it pays 5%.

But if there is high inflation, the TIP accretions preserve the real value of the original investment/interest payments while the CD is hopelessly erroded.


Jun 14, 2007 7:09 pm

I like to tell a story of Rip van Winkle who fell asleep in 1975 with enough  bonds to buy a new caddilac and but then couldn't buy new caddilac in 2005 when he woke up.

Rip should have bought a 1970 Hemi Cuda which sold for a cool 715,000 at the 2006 Barrett Jackson 2006 auction.  He could have bought several Cadillacs when he woke up.

http://www.barrett-jackson.com/appstest2/carlist/CarListFilt er.aspx?AuctionId=53

Or actually any of these Plymouths would have been a fine investment.

It just goes to show that you cannot predict the future.

Jun 14, 2007 7:12 pm

Hopelessly erroded.  Ahh, if only I could go back to undergrad and listen to more guys like you drone on and on about hypotheticals...

Bottom line is TIPS are a MEDIOCRE fixed income instrument at best. 

Jun 14, 2007 7:29 pm

All,

You don't have to explain to me why there are higher prices. From what I've seen of your reasoning, you only barely scratch the surface of where higher prices come from. It show that you understand the broad theory but not the practical application.

To use one of Mikebutler222's terms, you are moving the goal posts.

This is your very favorite of rhetorical devices. You talk for example of how long term munis are so bad as opposed to TIPs and when that comparison is deconstructed you then say 'well that's why you have these other investments to balance it off'. You say you're managing for CPI but then when it is shown to you that CPI is an inadequate comp, you say 'well that's why I manage to beat CPI'.

That's what "moving the goal posts" means.

Whatever, just so long as you know that I know that that's what you are doing.

I don't bother doubting your success in the business (mostly because it doen't make or cost me a peeeny for you to be whatever) and I do know that in the land of the blind, the man with one eye is king. I'm sure that clients that hear your rap are duely impressed. And then there are those who never take you phone call again (just like the rest of us). 

Jun 14, 2007 8:02 pm

[quote=Dust Bunny]

I like to tell a story of Rip van Winkle who fell asleep in 1975 with enough  bonds to buy a new caddilac and but then couldn't buy new caddilac in 2005 when he woke up.

Rip should have bought a 1970 Hemi Cuda which sold for a cool 715,000 at the 2006 Barrett Jackson 2006 auction.  He could have bought several Cadillacs when he woke up.

http://www.barrett-jackson.com/appstest2/carlist/CarListFilt er.aspx?AuctionId=53

Or actually any of these Plymouths would have been a fine investment.

It just goes to show that you cannot predict the future.

[/quote]

Exactly right!

Don't predict. Let the talking heads, and gurus predict.

Jun 14, 2007 8:29 pm

[quote=Whomitmayconcer]All,

You don't have to explain to me why there are higher prices. From what I've seen of your reasoning, you only barely scratch the surface of where higher prices come from. It show that you understand the broad theory but not the practical application.

That's what "moving the goal posts" means. [QUOTE]

CPI is just an attempt to measure something that is unmeasurable, which is each person's experience of rising prices. It's going to be imperfect. And its just a benchmark that is closest to the goals of my portfolio construction technique. If you just wanted to beat CPI I'd be AllTIPS and not AllREIT. But I'm real greedy, so I/clients want more.

It's the same an equity manager trying to beat the S&P 500 etc. For a real return strategy, your benchmark is CPI or TIPS.

The practical application of all this is trying to design a portfolio who's price appreciation and income stream grow faster than inflation. That is IMHO an achiveable goal and one worth fighting for.

I've hashed over why rolling along portfolios of nominal bonds (without reinvestment!) will gradually lead to a decline in purchasing power all else being equal. The accretions on TIPS can be thought of as being the same as holding back some of interest income from a nominal portfolio and reinvesting it, thus keeping up with inflation. However nominal bonds can only produce a limited maximum amount of reinvestment (the coupon rate), while TIPS accretion is unlimited.

And so I'm not going to go over that again.

[QUOTE] I'm sure that clients that hear your rap are duely impressed. And then there are those who never take you phone call again (just like the rest of us). 

[/quote]

I've said its big world with lots of options for everyone. I've got my niche, and I think I do ok in it as do my clients.
Jun 15, 2007 1:04 am

 "However nominal bonds can only produce a limited maximum amount of reinvestment (the coupon rate), while TIPS accretion is unlimited"

In the real world though, by the time the accretion made any difference to the underperformance you have locked in the rest of your portfolio would be so far underwater that it wouldn't help your client in the least.

The reason for this sad fact is that if CPI inflation hits those sorts of numbers (you might remember I disproved your theory at 10% inflation for 5 straight years) the rest  of the economy would be in a shambles (real estate especially included.)

What's worse is that you clients would be forced to hold the TIPs to maturity because they would be trading at a major league discount to their accreted value, in no small part due to the practically zero coupon nature of their interest payments.

Further, further, if we enter into this sort of cycle, don't you think that the financial factories on Wall Street will start pumping out competing products which will dampen the demand for TIPs paper? If a company thinks it can make money grow faster than the  rate of inflation, they'll gladly give you most of it if they can use your money to do so. We'll wind up with a plethora of IPSecurities with a higher coupon and an inflation rider. Your TIPS will be dead in the water.

This is what I mean about you just scratching the surface. You haven't been through a cycle and you don't have a full vision of what can and will happen. But then again, it's hard to look at the factors that disprove what we want to believe (in you case that there is a proper mix such that you can set up a portfolio and then go look for more money to set up the same as last time and charge an ongoing fee for having done so. It's an admirable goal, but then so was looking for El Dorado, and the Fountain Of Youth.)

Jun 15, 2007 4:08 am

[quote=Whomitmayconcer]

 “However nominal bonds can only produce a limited maximum amount of reinvestment (the coupon rate), while TIPS accretion is unlimited”

In the real world though, by the time the accretion made any difference to the underperformance you have locked in the rest of your portfolio would be so far underwater that it wouldn't help your client in the least. [/quote]

1) I'm not sure what point you're trying to make.

If I understand what you are saying, it doesn't make sense (which implies that I don't under stand it)

That's just silly, the inflation accretions keep the par value of any single TIPS equal to $1000 in real terms and the interest payments equal in real value to what ever they were at the time of issue.

With a nominal bond, the real value of the initial $1000 is slowly erroded by inflation as is the real value of the initial coupon.

In order for a portfolio of 5% nominal bonds to have the same value as 2.5% TIPS @ 2.5%, the nominal portfolio would have to hold back 2.5% to recreate the CPI accretion on the TIPS, and pay out the other 2.5%.

But if inflation runs at 6%, the nominal portfolio would not (could not! ) generate income for reinvestment, much less any income payout. The nominal portfolio would lose real value and generate no income.

This is the precise reason why no one except the treasury issues inflation linked debt. They can't be assured that the income from their assets will match inflation.


[quote]

The reason for this sad fact is that if CPI inflation hits those sorts of numbers (you might remember I disproved your theory at 10% inflation for 5 straight years) the rest  of the economy would be in a shambles (real estate especially included.)[/quote]

You have done no such thing,

And high levels of inflation have been seen before in the US, and much higher levels in various industrialised countries in the past (Italy Israel, UK). Saying that 10% inflation won't happen is making a big that it won't happen. In fact CPI-linked bonds were first introduced in 1981 in the UK.

[quote] What's worse is that you clients would be forced to hold the TIPs to maturity because they would be trading at a major league discount to their accreted value, in no small part due to the practically zero coupon nature of their interest payments. [/quote]

No, because TIPS trade at a %age of accreted face value. High inflation may or may not have an impact on real rates. If anything demand for TIPS would increase in an inflationary enviroment.

Precisely because of the inflation accretion, TIPS are the only investment that has no default risk *and* no inflation risk. Quite possibly the worlds most perfect investment.

[quote]Further, further, if we enter into this sort of cycle, don't you think that the financial factories on Wall Street will start pumping out competing products which will dampen the demand for TIPs paper? If a company thinks it can make money grow faster than the  rate of inflation, they'll gladly give you most of it if they can use your money to do so. We'll wind up with a plethora of IPSecurities with a higher coupon and an inflation rider. Your TIPS will be dead in the water.[/quote]

Nope, IMHO very little risk of this. Here's why,

CPI linked debt contains an embedded call option on inflation. Think back to the series 7, whats the maximum possible loss on a naked call option?
 

Debt with a constant real value could become a crushing burden to any issuer that couldn't grow in real terms. Since there is no easy way to hedge inflation, companies shy away from issuing real debt, but love to issue fixed debt.

Only the government, (via its proportionate taxation) has revenues that deterministicly grow at the rate of inflation or can be increased if needed. No one else but the US Treasury/State Governments can afford the risk of the naked call option.

Which brings to mind an interesting question about the risks taken on by  insurance companies/pensions who are doubly exposed to logevity and inflation risk on inflation linked liabilties (CPI annuities/pensions/LTCi)

[quote]This is what I mean about you just scratching the surface. You haven't been through a cycle and you don't have a full vision of what can and will happen. But then again, it's hard to look at the factors that disprove what we want to believe (in you case that there is a proper mix such that you can set up a portfolio and then go look for more money to set up the same as last time and charge an ongoing fee for having done so. It's an admirable goal, but then so was looking for El Dorado, and the Fountain Of Youth.)

[/quote]

I want to be disproven! I want challenges to my thinking. If there is a better philosophy to help clients meet their income/capital needs than Liability Driven Investing; I want to know about it.

Living expenses are correlated with inflation/age, not the S&P500. So it makes sense to invest accordingly. Just my $0.02.
Jun 15, 2007 5:45 am

Maybe I’m crazy folks, but my first read would be that AllREIT is on to something here.  These suckers(TIPS) are hard to understand, and they aren’t especially attractive because the “cash on the barrelhead” yield is WAAAAY below what we think of as ‘the market’ at any maturity.

parenthetically
Either way, I think this is cool, because(aside from a few snarky comments) we have some of the senior members of this forum(lots of experience and some serious mental horsepower) debating this issue without turning it into a big food fight.
end parenthesis

I ask you, what other instrument with a ROCK SOLID GUARANTEE can you purchase that provides you with ANY guarantee against  increases in the cost of living(or some facsimile thereof)?

And then there would also be the question as to what is said investment’s correlation to the stock market and the bond market.  I would think the correlation for TIPS to either would be rather low.

I’m too tired and it’s too late for me to get into a long dissertation about this, but perhaps this idea merits some further consideration from all.  I can say that in my career some of the BEST ideas I’ve ever had(in terms of added value) were the ones that were hardest to explain and most frequently pooh poohed by clients and colleagues alike.

Too, I’ve never traded TIPS myself, but I’ve observed some smart money trading them over the years.  More than once the thought has occurred to me that perhaps I need to spend a little more time and effort to understand the instrument a little better.  The biggest negative I’ve heard expressed(by anyone I respect-Mike Ryan at UBS formerly PaineWebber) is that the spreads on TIPS are pretty big.  That only matters if you expect to trade them frequently, IMHO.

I DO question whether REITs are a good instrument to compliment TIPs in a portfolio, because I do think they have some vulnerability to high-inflation environments.

But this is interesting, either way…

Jun 15, 2007 12:11 pm

L share variable annuity for liquidity, and a 6.5% lifetime income rider.

Jun 15, 2007 2:10 pm

"On May 1, 2005, Public Debt is raising the fee it charges for its Sell Direct service.

With Sell Direct, an investor who holds Treasury bills, Treasury notes, Treasury bonds, or Treasury Inflation-Protected Securities (TIPS) directly with Treasury asks us to sell his or her security before maturity. Acting on Public Debt's behalf, the Federal Reserve Bank of Chicago gets quotes from brokers and sells the security to the highest bidder. The sale proceeds, less a transaction fee, are deposited into the customer's account.

Since Sell Direct's inception in 1997, the transaction fee has been $34. Starting May 1, it will be $45. The increase is attributed to higher operating costs."

That's a non compounded rate of 3.2%, The operating cost went up higher than the rate of inflation? Not to mention that this is an electronic medium and the rate has been deflationary in that segment as memory and computing prices have plummetted since 1997!

And yet some how I'm supposed to be doing MY work for less and less or I'm some sort of greedy bastidge!

Jun 15, 2007 2:41 pm

[quote=AllREIT]

This is the precise reason why no one except the treasury issues inflation linked debt. They can't be assured that the income from their assets will match inflation.
[/quote]

This is untrue.  There are CD issues that are tied to CPI, as well as Agencies that have CPI based coupons.  I help you out, here's a couple:

Inflation-Floater Certificates of Deposit (IFCDs) Corporate Notes with Inflation Linked Coupons

I have some Sallie Mae CPI linked debt on the books as a matter of fact.  It's okay, it would be tough to know whats out there being on the outside looking in, isn't it...your Scottrade account probably doesn't have these things listed.

Aside from all this friendly banter, the truth is CPI is a poor indicator for retirees.  Truthfully, there should be two CPI numbers

1)  Healthy, middle aged Americans

2)  Retirees

The rate of inflation on medicines, healthcare, and assisted living (large portions of many retirees current or expected future budgets) has FAR exceeded the overall rate of inflation.

Solving for CPI for a retiree simply erodes there purchasing power, because it isn't enough.  Hence the explosion of products geared toward retires that are equity based with guarantees (aka VA's with GMIB that can increase).

We will just have to agree to disagree, but I wholeheartedly believe that a TIPS based portfolio is inadequate in keeping pace with a retiree's inflation rate, and thus will not sustain their purchasing power.

Jun 15, 2007 3:07 pm

To be fair, the inflation bonds (non TIP) so far are generally just an adjustment of the coupon rate.

Talk about investments that don't trade well! They make a portfolio of bond funds look good!

With a static portfolio in a rising inflation market, Allreit is right, TIPS are plenty hard to beat.

With an actively managed portfolio, I believe that I can beat TIPs. With a normal yield curve and a proper ladder you will beat TIPs. With a competant bond buyer running a portfolio (I mean me) you will probably beat them senseless, however you cannot give the same guarantee as you can with a TIP because you are not the USGovernment.

Jun 15, 2007 3:50 pm

[quote=ezmoney]L share variable annuity for liquidity, and a 6.5% lifetime income rider.[/quote]

The guarantee is solely dependent upon the insurance carrier.  There are now some “wise men” who think that the insurance companies are underpricing their guarantees, and that there could be some issues in the  event of an extended market decline.

Jun 15, 2007 4:03 pm

[quote=joedabrkr]Maybe I'm crazy folks, but my first read would be that AllREIT is on to something here.  [/quote]

The adjustment for CPI increases is fine. The problem is that comes at the expense of a low coupon. That's how they've under performed short-term CDs and at times, money market funds. In a high inflation environment, they're dandy, otherwise they're doomed to under perform (and that's before you get paid). You can explain to your clients about the CPI kicker until you're blue in the face, but underperforming short term alternatives is all that really matters.

Jun 15, 2007 5:20 pm

[quote=BankFC][quote=AllREIT]

This is the precise reason why no one except the treasury issues inflation linked debt. They can't be assured that the income from their assets will match inflation.
[/quote]

This is untrue.  There are CD issues that are tied to CPI, as well as Agencies that have CPI based coupons.  I help you out, here's a couple:

Inflation-Floater Certificates of Deposit (IFCDs) Corporate Notes with Inflation Linked Coupons

I have some Sallie Mae CPI linked debt on the books as a matter of fact.  It's okay, it would be tough to know whats out there being on the outside looking in, isn't it...your Scottrade account probably doesn't have these things listed.[/quote]

The funny part about most(all?) non-TIPS inflation linked debt is that it doesn't have the principal accretion feature of TIPS. When the instrument expires you get your $1000 back, instead of $2745, as with TIPS.

http://lasallebonds.com/ifcds/index.html

[quote]IFCDs are an investment alternative created to assist in offsetting the effects of inflation. IFCDs pay a monthly coupon that changes periodically, or “floats”, based on the change in CPI over the previous year. Instead of adding the inflation component of the return to the principal balance, like CDIPs or TIPS, this type of investment simply pays it out as part of each coupon payment. A portion of each interest payment is meant to offset inflation, and the remainder is the real return.[/quote]

This kind of note would require you to do the reivestment yourself (but would always provide you with enough to reinvest, unlike a nominal bond.)

I don't know too much about Lassale's CDIP's but I wouldn't be shocked, if they always yeilded a few bp less than equal maturity TIPS. Lasalle specialises in issuing structured products which are surely good for the bank, but for the customers.....

[quote]Solving for CPI for a retiree simply erodes their purchasing power, because it isn't enough.  Hence the explosion of products geared toward retires that are equity based with guarantees (aka VA's with GMIB that can increase).

We will just have to agree to disagree, but I wholeheartedly believe that a TIPS based portfolio is inadequate in keeping pace with a retiree's inflation rate, and thus will not sustain their purchasing power.[/quote]

Going directly for CPI is trying to make a best fit with the inflation linked costs of seniors and anyone else with living expenses. Equity investments, and classic mixed stock/bond portfolios are not the best fit to this problem.

The big risk with equity linked payments is what happens if you have high inflation *and* the stock market tanks at the same time. The classic example being the Carter Administration 1977-81.

If you want to sell TIPS to people of a certain age, just bring along a glossy photo of Jimmy Carter.

There may be some Annuitisation schemes that can help with this, but I think the equity link is a distraction. For example AIG offers a very nice CPI-linked SPIA through vanguard.


Jun 15, 2007 6:17 pm

[quote=mikebutler222]

[quote=joedabrkr]Maybe I'm crazy folks, but my first read would be that AllREIT is on to something here.  [/quote]

The adjustment for CPI increases is fine. The problem is that comes at the expense of a low coupon. That's how they've under performed short-term CDs and at times, money market funds. In a high inflation environment, they're dandy, otherwise they're doomed to under perform (and that's before you get paid). You can explain to your clients about the CPI kicker until you're blue in the face, but underperforming short term alternatives is all that really matters.

[/quote]

One of my concerns is how the CPI is measured.  We all know that CPI is sort of a bogus measure.  When you are retired, what types of expenses are non-negotiable?....utilities, food, taxes, healthcare.  Unfortunately, these tend to be a larger part of seniors' expenses - many things which rise (or have risen this past decade) faster than CPI ("inflation").  And I don't think a period of low inflation keeps these prices down.  So, I guess what I am saying is that many expenses for retired folks rise faster than would the adjustment to the TIPS. 

Correct? No?

Jun 15, 2007 7:05 pm

I guess what I am saying is that many expenses for retired folks rise faster than would the adjustment to the TIPS.  Correct? No

Yes and no I think

These are the categories that the CPI takes into consideration.  Not all people use the same services. Older people use less of some and rural/non uban older people use less.

FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, service meals and snacks)

Older people tend to eat less quanties and less out at restaurants. So this might be a push.  Food costs go up but consumption is going down.

HOUSING (rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture)

My clients mostly own their own homes and second homes.  The cost of insurance is rising but even if they don't own outright most have a fixed mortgage which isn't rising with inflationary housing costs. The cost of furniture is a non issue. However, the cost of heating is a big inflationary bugaboo.  But couple that with the fact that they have no or low mortgage payments.

APPAREL (men's shirts and sweaters, women's dresses, jewelry)

Again. Not a big issue for retirees. Most already have their own jewelry and aren't normally big clothing buyers.

TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance)

Here is a biggie if the retirees plan to travel much or routinely buy new cars. 

MEDICAL CARE (prescription drugs and medical supplies, physicians' services, eyeglasses and eye care, hospital services)

Another big inflation bite. Perhaps the biggest of all. But if your retiree is in good health and doesn't need these services, not so much of a issue.

RECREATION (televisions, pets and pet products, sports equipment, admissions);

Well other than possibly buying a new TV or set of golf clubs, this is also a non issue for most of my clients.  Except the ones who own horses

EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories);

By the time the retiree is retired they have no more college costs, if they ever did.  Not too many are heavy software users and I don't see that this is a big inflationary roadbump in retiree's lifestyles.

OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses).

These are things that retirees will continue to use, but possibly not as much as when younger.  Other than the funeral expenses, I expect retirees to use less.  Again probably a push.

I'm not saying we shouldn't plan for inflation and that CPI linked investements are foolish or the be all end all.  As advisors we need to look at our client's individual needs.  It seems to me that we are talking apples and oranges here.  Allreit is all numbers and theory. The rest of us deal with real people.

Jun 15, 2007 8:47 pm

[quote=mikebutler222][quote=joedabrkr]Maybe I’m crazy folks, but my
first read would be that AllREIT is on to something here. 
[/quote]

The adjustment for CPI increases is fine. The problem is that comes at the expense of a low coupon. That's how they've under performed short-term CDs and at times, money market funds. In a high inflation environment, they're dandy, otherwise they're doomed to under perform (and that's before you get paid). You can explain to your clients about the CPI kicker until you're blue in the face, but underperforming short term alternatives is all that really matters.

[/quote]

Mike, this is the difference between selling what is easy to sell and selling what is best for the clients.

The instantaneous cash return on TIPS vs Nominal instruments is less, but the total return is equal or potentially much higher.

In my experience most clients get this. Perhaps the clients who don't get this, don't work with me, so my sample is skewed.

Its pretty easy to explain to them. You can show in quick spreadsheet how the TIPS keeps its value while the nominal bond is worn to a stub by inflation.

I tell clients that you can put most investments into one of three categories.

Stable Cashflow, Growing Cashflow, and No Cashflow.

Stable Cashflow investments are naked to the risk of inflation, but they are stable. Hence I recomend owning some short treasuries.

Growing Cashflow investments, are your only defense against inflation and your best bet for real excess returns. But you have to choose wisely. TIPS are your only sure thing Growing Cashflow investment.

No Cashflow investments require that there be a sucker willing to buy when you want to sell. A risky proposition that requires the most careful analysis.


Jun 16, 2007 2:16 am
AllREIT:

[quote=mikebutler222][quote=joedabrkr]Maybe I’m crazy folks, but my first read would be that AllREIT is on to something here. 

The adjustment for CPI increases is fine. The problem is that comes at the expense of a low coupon. That's how they've under performed short-term CDs and at times, money market funds. In a high inflation environment, they're dandy, otherwise they're doomed to under perform (and that's before you get paid). You can explain to your clients about the CPI kicker until you're blue in the face, but underperforming short term alternatives is all that really matters.

[/quote]

Mike, this is the difference between selling what is easy to sell and selling what is best for the clients.
[/quote]

Newbie, please.

Making LESS than short term CDs and even money markets for the last three years (what's the return been, even before your fees, 3%?) so that your tiny coupon has the chance for CPI linked increases isn't "best for clients".

Jun 16, 2007 2:18 am

[quote=AllREIT] In my experience most clients get this. [/quote]

Yeah, I'm sure both of them are happy underperforming most every other short term fixed income investment. 

Jun 16, 2007 4:57 am

[quote=mikebutler222]

[quote=AllREIT] In my experience most clients get this. [/quote]

Yeah, I'm sure both of them are happy underperforming most every other short term fixed income investment. 

[/quote]

Mike, I'm going to let you have the last word on this one.


Jun 16, 2007 7:12 am

[quote=AllREIT]

[quote=mikebutler222]

[quote=AllREIT] In my experience most clients get this. [/quote]

Yeah, I'm sure both of them are happy underperforming most every other short term fixed income investment. 

[/quote]

Mike, I'm going to let you have the last word on this one.


[/quote]

A graceful 'retirement'.  I can learn from this!
Jun 16, 2007 4:00 pm

[quote=joedabrkr] [quote=AllREIT] [quote=mikebutler222]

[quote=AllREIT] In my experience most clients get this. [/quote]

Yeah, I'm sure both of them are happy underperforming most every other short term fixed income investment. 

[/quote]

Mike, I'm going to let you have the last word on this one.


[/quote]

A graceful 'retirement'.  I can learn from this!
[/quote]

We probably all can.