I sold my Vanguard TIPS and bought some WIW instead. The Vanguard TIPS fund was yielding 0.94% and its holdings had an average duration of 7.7 years and the Western Asset/Claymore fund had a yield of 6.1% and a duration of 8.0 years.  It seems too good to be true.  What am I missing?  I know that the holdings of the WIW fund are slightly different, but I don't see how this explains the large yield difference.

 Jos

"I know that the holdings of the WIW fund are slightly different"

Hi Jos,

I suppose it depends upon your definition of "slightly different". As you know, VIPSX is 100% AAA rated TIPS, except for a tiny cash position which M* shows as 0.14%.

Now take a look at the : WIW Annual Report dated 12/31/07. If you examine this report closely you can probably discern a number of rather major differences between the two funds.

Note on page 2 that the Investment Policy of WIW varies greatly from that of VIPSX.

Investment Policies

As previously announced, effective November 26, 2007, the Fund’s investment policies were revised to include, among others, that, under normal market condition, its portfolio be invested as follows:

Also note that only 85% of the WIW portfolio consisted of U.S.Govt. Obligations at the time of the report. The rest is spread in Yankee bonds, preferred stocks, and corporate bonds. 

Now scroll down a bit further and look at the Statement of Assets & Liabilities. You can see in the Liability section that there are a few "clues" to the "fancy footwork" WIW employs, and how they are able to pay a higher distribution. Note the entries for securities loaned, swap contracts, and options written. These are all forms of leverage used to boost the distribution.

Scroll down to page 18 and note the carryforward losses which WIW will undoubtedly use up before expiration to offset capital gains should the situation present itself. The use of the carryforwards might, at some point, result in part of the distribution being characterized as non-taxable, return of capital. This is an example of "good" ROC as it would replace distributions which would normally being characterized as as taxable capital gains, but would arise only if WIW sold portfolio securities for a gain (took profits).

As of December 31, 2007, the Fund had the following capital loss carryforwards remaining:

The next page, 19, shows open forward currency contracts (leverage).

Page 20 shows the options written and the credit default swap agreements (more leverage). 

So, even though the APS were redeemed in 2006, WIW still uses several forms of leverage in their strategy. 

Thus, through a combination of leverage and only 85% in TIPS, WIW is able to produce a 6% yield. And, WIW trades at a 10% discount to net asset value.

Hope that helps a little.

Best,

Steve 

Your analysis, as usual is excellent. I have recently bought and entry position in WIW as I thought the pros way outweighed the cons. I was aware of much of the information in your post, but your comments helped put a lot in context.

Most interesting to me is the fairly stable NAV of this fund since inception as well as a relatively stable distribution rate. All in all, I think that WIW is an excellent holding for somewhat low risk in a extremely low interest rate environment. I am curious as to your opinion on this fund.

Sid

It looks like there's a little confusion as to the actual "yield" of VIPSX.

Morningstar shows the trailing 12-month yield as 5.64%. Yahoo shows the yield as 5.52% as of 03/31/08. Both of those figures include the variable inflation adjustment.

The 0.94% yield figure comes from the Vanguard web site, with the following information:

"The yield quoted is the real yield, or the yield before adjusting for inflation. The actual yield on the Vanguard Inflation Protected Securities Fund will be a combination of the real yield and an inflation adjustment. A complete estimate of the fund's yield requires that an estimate of future inflation be added to the real yield. Because inflation fluctuates, it cannot be projected into the future precisely enough to be included in the yield quote. The inflation adjustment is based on changes to the Consumer Price Index and can either be positive or negative, based on the change to the CPI. Investors interested in maintaining the purchasing power of their investment should reinvest their dividend distributions."

Looking at VIPSX Historical Dividends we see that the quarterly payouts are all over the map. It looks as though Vanguard makes the inflation adjustments in June and December, since in those quarters the dividend is so much higher than in March and September.

Sid - to answer your question, I don't own WIW but I think it's a good holding for the reasons you mentioned. Reasonable NAV stability and dividend (one decrease and one increase since inception). I'd also throw in good sized asset base and good trading volume for a CEF, giving it better liquidity than most. 

The revised investment parameters, giving the fund wider latitude in their percentage of category holdings, might actually increase risk a little. However, that remains to be seen.

Finally, shareholder activist George Karpus has been reducing his stake in WIW over the past year, but still has a large position with 3.99% of outstanding shares as of his last SEC filing. He once owned 6.5%. Since he is no longer a 5% holder he probably is not required to file 13Ds anymore. Karpus was against the new investment mandate, and here's a cut/paste from letter he wrote to the Trustees about a year ago:

"Why is the Board making such dramatic changes to the Fund's investment policy? The weak explanation given in the Fund's press release is to "allow for more opportunities to further enhance shareholder value." It seems a stretch that allowing the portfolio manager to invest in areas of the bond market that he does not find attractive would enhance shareholder value. Perhaps the true reason for the proposed changes is to differentiate WIW from its sister fund the Western Asset/Claymore U.S. Treasury Inflation Protected Securities Fund (WIA). That way the Trustees can continue to receive two directors fees, auditors can continue to receive two audit fees, the attorneys can continue to receive two attorney fees, and the New York Stock Exchange can receive two listing fees; all at the expense of shareholders - some of which overlap both funds (which increases transfer agent costs).

What would enhance shareholder value? Merging these two funds together is a very common sense thing that could be done in order to reduce fund expenses and enhance shareholder value. Another thing the Trustees may have considered is the sunroof provision outlined in the Fund's original prospectus. This provision spells out remedies (such as tender offers, buybacks, and open-ending) that the Trustees would consider to narrow the Fund's discount. These are changes upon which the Trustees should have been focused, after all they do not manage the Fund's assets, they are stewards of the Fund's owners - the shareholders."

Best,

Steve 

Thanks for the clarification / info.  I guess Vanguard gets kudos for disclosure, but I bet their marketing people would like to slit their wrists -- not a lot of folks make it through the first line of explanatory text.

Regards, Dick

Thanks to all for their comments.  While walking, I came to same conclusion regarding the principal adjustment and had started a post on the reconciliation, but noticed the post by Steve (Schreinstein) and pulled mine.  I still feel that the WIW is the better investment even after Vanguard's principal adjustment and will keep holding it, although I haven't done the due diligence to back it up the conclusion.

 Dick, I think it was you in an earlier post that alerted me to WIW.

Thanks

 Jos

Interesting discussion; thanks for the details. Before reading this I had done my own research into WIW vs. VIPSX.  When I was able to find comparable statistics (not a simple process), I found WIW ahead on yields only 3.2. to 3.1% YTD: 6.07% to 5.64% TTM; and behind 10.6 to 11.6 for 2007.  And WIW has a larger expense ratio, .75 to .20.

That's pretty much a wash, so I'm leaning toward VIPSX as less risky.

My question now is, when to start investing in TIPS? The returns are quite low now-- I don't even know where to find the nominal return rates among all the bond price tables. 

Any advice on that?

aalan 

As I wrote previously, for whatever it's worth, Bill Gates, through his investment vehicle Cascade Investments owns shares in both WIW and its fraternal twin WIA, but does not, apparently, own shares in VIPSX.

Something else I find interesting is that there is a new ETF that invests in not only American inflation-protected bonds, but foreign ones as well. It's the SPDR DB International Government Inflation Protected Bond fund, ticker WIP. The fund's largest position is in inflation-protected, euro-denominated French OATS, but other top holdings include UK, Canadian and Brazilian inflation-protected bonds. Credit quality is AA-.

Any comments on this one? 

Jagor

It may not include US inflation protected bonds. Haven't seen the complete list of holdings, but there appear to be none in the top 25.

"The investment objective of the Fund is to provide investment results before fees and expenses correspond generally to the price and yield performance of the DB Global Government ex US Inflation Linked Bond Capped index. The Index measures the performance of the inflation linked government bond markets of developed and emerging market countries outside of the United States. Inflation protected public obligations of the Index commonly known in the United States as Treasury Inflation Protected Securities, are securities issued by such governments that are designed to provide inflation protection to investors."    -etfconnect

The whole purpose of WIP is not to hold any U.S.-dollar denominated TIP's.  It is a multiple hedge against a falling dollar, through potential foreign currency appreciation, the semi-annual adjustment of the principal according to the inflation rate of the base currencies, and the interest payments from the bonds themselves.  Of course, in the case of a rising dollar, WIP is less interesting.

Jagor 

Hello Jagor,

I think this ETF as you said could be a good hedge against the dollar.

I like that it is diversified.

One thing to be aware of, is that 10.25% of the bonds

are below Baa, and its history is only three month.

Thomas 

Thomas is correct on all points.  WIP is very new and is still building its portfolio. I intend to keep it on my watch list for a while to see how it moves. 

Theoretically it is, indeed, a good diversification for dollar-based portfolios. 

Apparently it is the only way for Americans to invest in non-dollar inflation-adjusted bonds. There is a similar instrument that is only available for European investors

Jagor 

Hi again.  My comment aout the WIP portfolio was occasioned by your earlier post which might have been construed to mean the fund includes US TIPS::"Something else I find interesting is that there is a new ETF that invests in not only American inflation-protected bonds, but foreign ones as well."

I'd appreciate a broader discussion of whether foreign sovereign bonds, whether inflation protected or not, are a good place to be in a globally inflationary environment. Some of WIPs portfolio seems to be issued by emerging and other less credit-worthy countries and denominated in local currencies which could lose significant  value against the US$ during  inflation.   The net return to US$ investors doesn't seem clear.

Perhaps the larger question is whether fixed income investments, adjusted or not, compete with hard assets, such as energy, materials and resources (maybe even real estate),  and the equities that own them,  during a period of forecast high inflation. Thanks in advance!!    Bill

 

Chamois,

Oops!  My mistake!  My face is red. I wasn't thinking clearly when I wrote that previous post.

That said, I already own three closed-end funds that invest exclusively in emerging-market debt, but not inflation-index bonds, at least to my knowledge. 

The reasoning behind this is that, although once upon a time in the not too recent past emerging market debt was not very "credit-worthy," that has radically changed in the last several years.

With respect to the issue of credit-worthiness and to the subject of emerging-market debt in general, I refer you to the very informative question-and-answer fund commentaries [one in August and one in December 2007] with Eric Baurmeister, one of the co-managers of the Morgan Stanley Emerging Markets Domestic Debt fund EDD.which is available both as PDF documents an audio files. 

Since Morgan Stanley has an infuriatingly execrable website [I had to drill down about five or six levels to find those commentaries], you will have to go to the link below--copy and paste--then scroll down to find the items in their Commentary Archive.

 http://www.morganstanley.com/msim/portal/site/US/template.PAGE/?msimPageTitle=commentary_archive&u=86bb14f4dc87daf33d3afb1051a9e009 

Jagor  

Thanks for that link; I certainly wasn't knocking the inclusion of foreign sovereign debt, including inflation adjusted bonds, in a diversified portfolio.  I do the same, using AWF (I assume AWF could include foreign tips at the PMs discretion) .  I was raising the issue of outcomes other than  ones assumed by CEF portfolio managers in  allocating funds within the bounds of their charters.  Baumeister, for example, uses Indonesia as a current EM investment model with a capital surplus and good economy. 

In 1996, that also described the country, but with the financial crisis erupting in Thailand, floating of first the Thai Baht and then the ID Rupiah, hot foreign money fled, the Suharto government fell and the rupiah lost more than  two thirds of its value against the US$. If Indonesia had TIPS outstanding at the time, the inflation adjustment would not have compensated US investors for the forex loss.  The same was subsequently true in other countries that  fell victim to the spreading SEAsia financial crisis, eg, Japan, Brazil, Mexico, S.Korea. 

Baumeister's view that it's different this time with EM is an assumption that needs to be questioned, and I'm just wondering whether the inflation protection overrides the lower rates currently paid on these bonds, since EM inflation is often accompanied by loss in local currency value against the dollar..

I can readily see the potential advantage of  sovereign TIPS for the people living in those local currencies, but I am wondering about the net benefit to those of us in US$. It's in the form of a question rather than assertion.    Thanks again for the response and best wishes.
 

Interesting article in Monday's Bloomberg  on US TIPS

TIPS 

Chamois's remarks about non-dollar denominated TIP's are very astute and worthy of consideration. 

I should only repeat what I posted earlier, that the portfolio of the SPDR DB International GovernmentInflation Protected Bond fund, ticker WIP, is mostly composed of developed country inflation-protected bonds, not emerging-market country bonds.

According to the latest data, as of May 16, 2008, the top country weights are: France 19.33%, U.K. 18.65%, Sweden 5.97%, Canada 4.82% and Italy 4.79.%

Bonds from Brazil, Mexico and Greece each compose less than 5% of the portfolio.

If inflation is a world-wide problem--and I know that inflation in France, estimated at an annual rate of 3.2%, is running at the highest rate in 17 years--then we may want to consider adding WIP to our portfolios. 

Jagor