As part of an email interview with John Hollyer, co-manager of the Vanguard Inflation-Protected Securities Fund, I asked, “How does the Vanguard Inflation-Protected Securities Fund differ from other TIPS funds?”
How does the Vanguard Inflation-Protected Securities Fund differ from other TIPS funds?
One of the key themes that we have pursued since the fund’s launch nearly 10 years ago, is that we really value those unique features that I touched on earlier: a TIPS market that is virtually a US Treasury market (free from default risk) and the unique properties of TIPS bonds due to their inflation indexation.
No Credit Risk in the Vanguard Inflation-Protected Securities Fund
What we have done is constrain our strategy tool kit so that we don’t distort, cover over, or in any way diminish those two very important differentiating features. For example, in the history of the fund, we’ve never used any investments that are subject to credit risk (and we have the freedom to do that under our Prospectus, because we write the Prospectus to be broad enough for the fund to handle different conditions, should they arise).
But we have not used them (bonds with credit/default risk) and we don’t have any plans to use them at this point. Some of our competitors have stubbed their toe or had return volatility and losses associated with exposure to credit instruments that maybe would not have been expected to be in a TIPS fund, and also which caused the return pattern of the fund to be different than the TIPS market.
The Yield Curve and the Vanguard Inflation-Protected Securities Fund
We typically will keep the portfolio focused on strategies like minor adjustments to the interest rate sensitivity of the fund to changes in real rates or, occasionally, to changes in the conventional Treasury Market. We’ll over and underweight individual TIPS issues along the TIPS yield curve based on our assessment of their relative value.
Breakeven Inflation and the Vanguard Inflation-Protected Securities Fund
We will occasionally take strategy positions on the relative value of TIPS versus conventional Treasuries, frequently assessed by a statistic called breakeven inflation; the amount of inflation that would have to take place over the life of the TIPS bond to cause its return to be equal to that of a comparable maturity nominal bond. The breakeven inflation can be estimated by taking the yield to maturity of a conventional Treasury bond, then subtracting from it the real yield of a maturity-matching TIPS bond. Currently, the 10-year area of that breakeven inflation measure is about 2.35% (as of March 2010).
For the entire interview with John Hollyer: An In-Depth Look at TIPS with Vanguard's John Hollyer.