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Author: xcskier One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35365  
Subject: Re: TIPS funds vs straight bond funds Date: 1/18/2005 10:17 PM
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lokicious: thanks for your reply.

>Assuming you are dealing with funds buying bonds with roughly the
>same maturities (durations are apparently hard to calculate for TIPS)

Morningstar classifies TIPS funds as intermediate-term. That's why I compared them to interm-term bond index funds of the same company. I agree, "term" isn't exactly the same as "duration", but that problem should apply equally to TIPS and straight bond funds.

>This is because TIPS have two components: the fixed portion of
>the yield and the inflation component

My understanding is that the TIPS interest RATE is fixed for the life of the bond, but the amount of PRINCIPAL (the face value) is adjusted at each coupon payment by the amount of inflation since the time of sale of the bond. So the interest payment will vary from coupon to coupon depending on how inflation is doing. I don't understand, what is the "fixed portion of the yield"? Or do you mean, "TIPS FUNDS have two components..."? In which case, wouldn't those components be the same for TIPS and intermediate-term bond (funds)?

Anyway, the preceding discussion is how I came to my hypothesis: if both bond funds are buying bonds of the same term, but the TIPS coupons rise/fall with inflation, then shouldn't whatever difference there may be in the returns of the two funds depend on inflation? Based on the available historic returns (a benign-inflation environment), I can't see any inflation-dependant difference between the two funds.

So what might be the cause of the difference in the actual returns? Could it be that TIPS and straight-bond funds are actually buying apples and oranges? I.e., although the bonds each purchases may be labelled "intermediate-term treasuries" at the time of sale, their different auction prices set them on different paths of behavior as time and interest rates vary?

Why should this be of any interest? Because if the only consistent advantage of TIPS over straight-bond funds is during periods of rapidly rising inflation, then I'll reduce the risk and wait until then to buy TIPS.
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