Morningstar - Q1 2023 - 11

-9
-12.78
EXHIBIT 2
A large real yield means that investors refuse
to own TIPS unless they receive a much greater
return than the level of future inflation. In
contrast, a negative real yield indicates that buyers
desire TIPS so strongly that they will give
up purchasing power to own them. They are, to
use the phrase of my colleague Paul Kaplan,
the marketplace's " willing losers. "
The latter, in fairness, is not strictly correct. If the
real yield on TIPS becomes even more negative,
then investors who own those securities can
resell them at a profit. Unless one holds TIPS until
they mature, their eventual total returns are
uncertain, because the marketplace's decisions
will affect the outcome.
Which is exactly what happened-but in
reverse. From spring 2020 through December 2021,
TIPS had been abnormally costly, carrying
their deepest negative yields ever. In 2022, that
premium collapsed. Within nine months, TIPS
went from being more expensive than at any time
during the past decade to being unquestionably
cheaper. EXHIBIT 2 shows the real yields for
10-year TIPS over the past decade; the story for
the five- and 30-year versions is similar.
If it seems strange to you that securities
designed to fight inflation would implode when
first faced with that very event, join the crowd.
Although investment professionals realized
before the fact that market movements could
disrupt the inflation protection offered by
TIPS, few (if any) expected this level of carnage.
Then again, from disaster comes opportunity.
Perhaps TIPS have fallen far enough to become
compelling. There are two perspectives on
this topic: (1) as a buy-and-hold investment and
(2) as a marketplace security. In the first case,
the salient question is, " If I stash away TIPS
for 10 years, will I be pleased with my decision? "
In the second, the issue is whether TIPS
will become cheaper yet. If so, there's no point
in buying TIPS now, since soon they may
cost even less.
Buy and Hold
The first angle is easy to address. Unusually,
TIPS possess explicit real yields. The underlying
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-15
1-5 Years
-14.48
Real Yields, 10-Year TIPS Real yields on TIPS are higher than they've been in
more than a decade.
5-10 Years
4%
2
1.58
-2
2003
2007
2011
2015
Source: FRED, Federal Reserve Bank of St. Louis. Data from Jan. 1, 2003, through Nov. 1, 2022.
2019
EXHIBIT 3
Real Returns of 10-Year Treasuries TIPS are a more compelling long-term
investment today.
6%
5.40
4
2
-2
1990s
1980s
2000s
1960s
Source: Morningstar Direct, govinfo.gov, author's calculations. Data as of Nov. 1, 2022.
TIPS (Nov. 1)
2010s
1970s
4.12
3.05
1.77
1.64
1.48
-0.64
mechanics resist simple explanation, because
market movements affect the calculations
(for example, a security initially issued with a
positive real yield can be repriced to have
a negative real yield), but suffice it to say, the
return for TIPS that will be held to maturity,
after inflation, is known in advance. (Not precisely
because of reinvestment risk, but close enough
for a blogger.)
3%
2
1
As of Nov. 1, the amount for a 10-year TIPS is 1.6%.
Buy a freshly issued 10-year TIPS, store it in an
01/2003
01/2008
electronic locker, and a decade from now that
security will have returned an annualized
1.6 percentage points above the rate of inflation,
as determined by the unadjusted version
of the Consumer Price Index. (Again, this account
is the abridged version of a longer but
substantially similar story.)
Real Yields
2.52
We can compare that 1.6% against what
conventional 10-year Treasuries historically have
earned ( EXHIBIT 3 ). As 10-year Treasuries
debuted in 1953, I started my inquiry in January
01/2013
01/2018
11/2022
morningstar.com/products/magazine
11
Monthly Implied-Inflation Rate
Annualized Return After Inflation
Monthly Real Yield
Year-to-Date Return

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Morningstar - Q1 2023

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