2010 Market Returns on TIPS

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The TIPS market performed quite well during 2010, though not quite as well as straight Treasurys.  Overall, TIPS returned 6.1% vs. Treasurys 7.2%.  After modest gains of 0.5% in the first quarter, TIPS prices soared during the 2010 second quarter and the momentum carried well into the third quarter.  During the fourth quarter, however, TIPS returns turned negative, following Treasurys, as fears about the economic rebound began to fade.

The chart below shows the TIPS yield curve at the end of 2009 and the first three quarters of 2010:

Chart 1
TIPS yield curve: Dec. 31, 2009, March 31, 2010, June 30, 2010, Sept. 30, 2010 and Dec. 31, 2010

  Source:  Barron's,  Wall St. Journal

2010 Performance

During the 2010 first quarter, both TIPS and Treasurys struggled to hold on to their gains.  TIPS generated an average return of 0.5%, Treasurys 1.2%.  The first quarter average TIPS return reflected a modest decline in principal, which partially offset interest earned.

The first quarter's weak relative performance was not unexpected.  TIPS should have underperformed as the economy improved.  However, that underperformance reversed course sharply in the second quarter, as the stock market correction took hold and evidence about weaker-than-anticipated improvement in the economy began to emerge.  Investors began once again to flock to TIPS as a safe haven.

For the second quarter, TIPS posted an average return across all maturities of 4.2%.  This was better than every other fixed income sector, except U.S. Treasurys.  Comparable maturity Treasurys delivered a total return of 7.0% in the 2010 second quarter.  In general, longer maturities performed best, with some issues posting solid double-digit returns for the quarter.

For the third quarter, TIPS posted an average return across all maturities of 2.7%.  This was below the returns across all other fixed income sectors, except mortgage backed securities.  Comparable maturity Treasurys delivered a total return of 3.4% in the 2010 third quarter.  As in the second quarter, longer maturities performed best.

In the fourth quarter, average returns on TIPS were -1.3%, with losses on medium- and long-term TIPS more than offsetting modest gains on shorter-maturity TIPS.  Treasurys were weaker, however, posting an average loss of 4.3%.

TIPS yields ended the year in positive territory, just off of historical lows.  The five-year TIPS note closed the year at 0.18%, well above its 2010 low of -0.49% set October.

Chart 2
5-year Constant Maturity TIPS yields: 2010

Source:  U.S. Federal Reserve

Ten-year TIPS closed the year at 1.00%, also well above their October low of 0.41%.

Chart 3
10-year Constant Maturity TIPS yields: 2009-2010

Source:  U.S. Federal Reserve

With the decline in yields, TIPS performance was strong in 2010, but not as strong as returns on straight Treasury securities.  A summary of their average performance by maturity group for each quarter in 2010 is given in the tables below:

Table 1
Yield and Performance on TIPS vs. Comparable Maturity Treasurys: 2010 First Quarter

 

TIPS

Comparable Treasury

Breakeven

Return

Return

Averages

Yield

Yield

Spread

on TIPS

on Treas.

2010-2014 maturities

-0.33%

1.36%

1.68%

0.7%

1.0%

2015-2020 maturities

1.20%

3.23%

2.03%

0.5%

1.2%

2025-2032 maturities

2.12%

4.51%

2.39%

0.2%

1.4%

Totals

0.97%

2.99%

2.03%

0.5%

1.2%

Source:  Lark Research estimates calculated from pricing data obtained from the Wall St. Journal.  Returns on TIPS and comparable maturity Treasurys were calculated from Dec. 31, 2009 to Mar. 31, 2010.

The strongest gains in TIPS were recorded in the short-term maturity group.  Yields on these TIPS fell to below zero on average, indicating that investors were willing to accept a negative real yield in exchange for safety and a modest degree of inflation protection.

Table 2
Yield and Performance on TIPS vs. Comparable Maturity Treasurys: 2010 Second Quarter

 

TIPS

Comparable Treasury

Breakeven

Return

Return

Averages

Yield

Yield

Spread

on TIPS

on Treas.

2010-2014 maturities

0.20%

0.81%

0.60%

0.8%

1.8%

2015-2020 maturities

0.71%

2.23%

1.59%

3.9%

7.7%

2025-2032 maturities

1.65%

3.68%

2.03%

8.2%

11.6%

Totals

0.82%

2.22%

1.40%

4.2%

7.0%

Source:  Lark Research estimates calculated from pricing data obtained from the Wall St. Journal.  Returns on TIPS and comparable maturity Treasurys were calculated from March 31, 2010 to June 30, 2010.

In the 2010 second quarter, total returns on TIPS and straight Treasurys were decidedly positive.  The greatest gains were recorded on longer-maturity issues.  Yields and breakeven spreads dropped, although the yield on short-term TIPS became positive, indicating that this segment had underperformed.

Table 3
Yield and Performance on TIPS vs. Comparable Maturity Treasurys: 2010 Third Quarter

 

TIPS

Comparable Treasury

Breakeven

Return

Return

Averages

Yield

Yield

Spread

on TIPS

on Treas.

2010-2014 maturities

-0.00%

0.47%

0.47%

0.7%

1.1%

2015-2020 maturities

0.29%

1.79%

1.50%

3.0%

3.7%

2025-2032 maturities

1.35%

3.28%

1.93%

4.6%

5.5%

Totals

0.50%

1.80%

1.30%

2.7%

3.4%

Source:  Lark Research estimates calculated from pricing data obtained from the Wall St. Journal.  Returns on TIPS and comparable maturity Treasurys were calculated from June 30, 2010 to September 30, 2010.

In the 2010 third quarter, total returns on Treasurys were 3.4% compared with 2.7% on TIPS.  Yields on TIPS and straight Treasurys are hovering near historic lows.  Breakeven spreads are lower than the historical average, but surprisingly not as low as one might expect.  The relative underperformance of TIPS vs. straight Treasurys helped cushion the decline in breakeven spreads.

Table 4
Yield and Performance on TIPS vs. Comparable Maturity Treasurys: 2010 Fourth Quarter

 

TIPS

Comparable Treasury

Breakeven

Return

Return

Averages

Yield

Yield

Spread

on TIPS

on Treas.

2010-2014 maturities

-0.27%

0.63%

0.90%

0.7%

-0.3%

2015-2020 maturities

0.46%

2.43%

1.97%

-1.1%

-4.8%

2025-2032 maturities

1.65%

4.04%

2.39%

-3.6%

-7.3%

Totals

0.57%

2.32%

1.75%

-1.3%

-4.3%

Source:  Lark Research estimates calculated from pricing data obtained from the Wall St. Journal.  Returns on TIPS and comparable maturity Treasurys were calculated from September 30, 2010 to December 31, 2010.

In the 2010 fourth quarter, total returns on Treasurys were -4.3% compared with -1.3% on TIPS.  Shorter maturity yields on TIPS declined further as they continued to rally, but medium- and long-maturity TIPS yields increased.  Since Treasurys fell more sharply, breakeven spreads widened by an average of 45 basis points in the quarter to 1.75%.

The breakeven spread is the difference between the yield on a straight Treasury security and the TIPS with the comparable maturity.  This difference is viewed by many analysts as the implicit rate of inflation that is "built" into the straight Treasury yield.  For example, the breakeven spread between a 10-year Treasury Note yielding 3.50% and a 10-year TIPS yielding 1.50% is 2.00%.  All other things being equal, if you believe that inflation will average 2.00% over the 10-year period, then you should be indifferent between buying the Treasury Note or the TIPS.  If you think that the average rate of inflation will be higher, you will earn more with the TIPS (because the annual inflation adjustment to principal will be higher).  If inflation is less, the 10-year Treasury Note will give you a higher return.

Chart 4 provides the spread between 10-year T-Notes and 10-year TIPS for 2010.  It shows that the spread declined steadily until the end of August, reflecting increasing concerns about the sustainability of the economic recovery.  As the stock market began to recover, however, spreads increased.  The 10-year weekly average spread closed the year at 231 basis points, down only 5 basis points from the beginning of the year.  Its historical average (2003-2010) is 217 basis points.

Chart 4
The Spread between the yields on the 10-year Constant Maturity TIPS and 10-year Constant Maturity Treasury Note: 2003-2010

Source:  Lark Research calculations from U.S. Federal Reserve data

The 5-year weekly average spread likewise recovered from its August low of 122 basis points to close at 182 basis points, only modestly below its 2003-2010 average of 1.97%.

Chart 5
The Spread between the yields on the 5-year Constant Maturity TIPS
and 5-year Constant Maturity Treasury Note: 2003-2010

Source:  Lark Research calculations from U.S. Federal Reserve data

Returns on TIPS mutual funds are given in Table 5 below.  Average fund returns are roughly consistent with my total return calculations for the underlying TIPS, after taking into account management fees.  Difference between returns on the individual securities vs. the mutual funds may also be due to the relative average maturities of the mutual funds.

Table 5
2010 Performance on Selected TIPS Mutual Funds

       

Performance

 

 

NAV

4th

One

Three

Five

Fund Name

Ticker

31-Dec-10

Quarter

Year

Year

Year

Am. Cent. Inv. Infl. Adj. Bond

ACITX

11.80

-1.07%

5.49%

4.91%

5.09%

BlackRock Infl. Prot. Bond A

BPRAX

10.79

-0.96%

5.82%

5.32%

5.64%

Dimensional Infl. Prot. Sec.

DIPSX

11.30

-0.97%

6.81%

5.34%

NA

Fidelity Infl. Prot. Bond

FINPX

11.64

-0.72%

5.89%

4.30%

4.40%  

T. Rowe Price Inf. Prot. Bond

PRIPX

11.98

-0.78%

6.29%

4.84%

5.07%  

Schwab Infl. Prot. Sel.

SWRSX

11.73

-0.97%

5.82%

4.26%

NA

Vanguard Inf. Prot. Bond

VIPSX

13.00

-0.74%

6.17%

4.55%

5.07%  

  Averages

 

 

-0.89%

6.04%

4.79%

5.05%  

 
  Source:  Morningstar

2010 Wrap-Up and Preliminary 2011 Performance

Table 6
Yield and Performance on TIPS vs. Comparable Maturity Treasurys: 2010

 

TIPS

Comparable Treasury

Breakeven

Return

Return

Averages

Yield

Yield

Spread

on TIPS

on Treas.

2010-2014 maturities

-0.27%

0.63%

0.90%

2.97%

3.60%

2015-2020 maturities

0.46%

2.43%

1.97%

6.24%

7.52%

2025-2032 maturities

1.65%

4.04%

2.39%

9.27%

10.57%

Totals

0.97%

2.32%

1.75%

6.07%

7.15%

Source:  Lark Research estimates calculated from pricing data obtained from the Wall St. Journal.  Returns on TIPS and comparable maturity Treasurys were calculated from Dec. 31, 2009 to Dec. 31, 2010.

See our other reports using the following links:
2009 Market Return on TIPS:  www.larkresearch.com/tipsreturns2009.htm
2011 Market Return on TIPS:  www.larkresearch.com/tipsreturns2011.htm

For additional commentary on TIPS performance as well as ongoing analysis of stock, bond and mutual fund investments, subscribe to Income Builder, a newsletter published by Lark Research.  You can view sample reports and take advantage of a special introductory subscription offer at www.larkresearch.com/income_builder.

Updated June 26, 2011

Stephen P. Percoco
Lark Research, Inc.
P.O. Box 768
Norwood, MA  02062
www.larkresearch.com

(732) 763-0763
incomebuilder@larkresearch.com

2011  Lark Research, Inc.  All Rights Reserved.  Information is carefully compiled but not guaranteed to be free from error.  Specific reference to any specific security should never be construed as a solicitation to either buy or sell.  Reproduction without permission from the publisher is prohibited.

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