by Dan Wiener | November 17, 2012 6:30 am
It finally happened: Vanguard launched the new Vanguard Short-Term Inflation-Protected Securities Index Fund (VTIPX) on time, bringing to life a little step-brother to its Treasury Inflation-Protected Securities (TIPS) market behemoth Vanguard Inflation-Protected Securities Fund (VIPSX).
The new TIPS fund has one very unique difference from the original besides its short-term focus: It’s index-based, and that means it not only has Investor and Admiral shares (VTAPX) (as well as $5 million minimum Institutional shares) but it also has ETF shares (VTIP) available. I think the ETF shares are going to be the most popular by far, given that Vanguard is charging a 0.25% front-end load to buy the open-end fund shares, which translates into a load of $25 on a $10,000 investment. While that doesn’t sound like much, in this low, low interest-rate environment where every dollar counts, the front-end load could be a turn-off for penny-pinching investors. As you might expect, expenses are low. Vanguard has set expenses for the Investor shares at 0.20% and on the Admiral and ETF shares that number falls to 0.10%.
Short-Term Inflation Index will aim to track the Barclays U.S. Treasury Inflation-Protected Securities 0–5 Year Index. Gemma Wright-Casparius, manager of Inflation-Protected Securities, and Joshua Barrickman, who manages several bond index funds, including Vanguard Intermediate-Term Bond Index Fund (VBIIX), share duties on the portfolio.
The new fund will go head-to-head in the ETF space with the iShares Barclays 0–5 Year TIPS Bond ETF (STIP), which currently has about $400 million in assets and, as the name suggests, tracks the same index. Bond giant PIMCO is another competitor, offering another short-term TIPS option, the PIMCO 1–5 Year U.S. TIPS Index ETF (STPZ) with close to a billion dollars in assets.
As I suggested when Vanguard first filed papers on this new fund over the summer, I think Short-Term Inflation Index could be seen as a money-market alternative for investors who don’t have an immediate plan to use their cash, but don’t want to venture too far out into the bond universe — preferring to invest in something that at least guarantees, or comes close to guaranteeing, they won’t lose value to inflation.
Vanguard says the fund seeks to provide “protection from inflation.” Notice that Vanguard does not say that the fund seeks to provide “inflation protection and income,” which is how they described the original Inflation-Protected Securities when it was introduced. Simply put, this new fund is all about socking money away and preserving its present value in inflation-adjusted terms. Nothing more and nothing less, and in the low-interest-rate environment we’re in today, there probably won’t be any more than that for a long time.
Because it is a bond fund, and there is a risk of loss, Vanguard makes it clear that this new fund is not a money market. However, on the risk scale, they say it’s akin to a money market or a fund like Short-Term U.S. Treasury, ranking a “risk potential” of 1, or as they term it, “Less risk, Less reward.” It earns this ranking because, as Vanguard puts it, “share prices are expected to remain stable or to fluctuate only slightly. Such funds may be appropriate for the short-term reserves portion of a long-term investment portfolio, or for investors with short-term investment horizons (three years or less).”
What exactly does low risk mean when you’re talking about Short-Term Inflation Index, or at least the index it will track? Take a look at the table below. You can see that, based on 10 years of data, the short-term TIPS index generated an average return over both three- and 12-month time periods that was substantially above that of a fund like Vanguard Prime Money Market Fund (VMMXX), though of course it also can, as I said, generate losses, which Vanguard’s money funds never have.
As the graph below shows, the Barclays 0–5 Year TIPS index has outpaced inflation and cash since its inception in 2002, while reducing the volatility and drawdown of its longer-duration sibling. To be clear, make sure you notice the drawdown experienced in late 2008, as investors’ demand for safety and liquidity hurt inflation-bond prices.
The short-term Barclays index’s maximum cumulative loss, or MCL, is -8.0%, a loss sustained over three months during the 2008 financial crisis. (If I assume the index return is reduced by 0.10% in annual operating expenses the MCL is -8.2%.) Inflation-Protected Securities lost 12.5% during the crisis. The index took nine months to recover its loss while Vanguard’s fund took 11 months to recover — remember that the longer fund has a much higher yield, which works to its advantage on the upswing. With a recovery of just nine months, the short-term fund fits well within Vanguard’s “three year” time frame mentioned earlier.
Seeing that precipitous decline in 2008, you might be asking, “Aren’t TIPS safe and liquid?” TIPS are definitely safe — arguably safer than Treasury bonds, as they come backed by the government’s full faith and credit and also protect your money against inflation. However, they are not as liquid, and in 2008, liquidity was in high demand.
The short-term TIPS market is thin — the current Barclays index contains a bit more than a dozen issues, or bonds. This could lead to concerns about limits to capacity for the fund, but I suspect that the original TIPS fund will serve as a source of bonds. As the longer maturity fund looks to sell bonds that near their maturity dates or become too short-term to continue holding, this new fund would be a natural buyer. Cross-trading is not uncommon at fund firms.
Short-Term Inflation Index could find a place in many conservative portfolios, as the underlying TIPS index has shown a higher correlation to inflation than long-maturity TIPS since they are less interest-rate sensitive. Vanguard has written a paper on just this phenomenon and says that “a short-term TIPS portfolio may be a more appropriate inflation-sensitive investment than the broad TIPS market for risk-averse investors who want their total portfolio to more closely track realized CPI inflation over short horizons.”
I expect that almost nonexistent money market yields and concerns over rising inflation may be key drivers of demand for this short-term alternative. But I also suggest you hold off buying Short-Term Inflation Index until the managers have some money under their belts and trading in the ETF gains some volume.
Senior Editor Dan Wiener and Editor/Research Director Jeffrey DeMaso publish The Independent Adviser for Vanguard Investors, a monthly newsletter that keeps abreast of recent developments at Vanguard, and the annual FFSA Independent Guide to the Vanguard Funds.
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