(PUB) Investing 2015

THERE IS NO WAY AROUND IT; it’s been an uninspiring first three years for Short-Term Inflation-Protected Securities Index . Following the fund’s October 2012 launch, I suggested that this little brother to the older, longer- maturity Inflation-Protected Securities could be seen as a money market alter- native for investors who didn’t have an immediate plan to use their cash. Vanguard said that the fund seeks to pro- vide “protection from inflation.” Well, the fund failed on both accounts. Before diving into the numbers, let’s briefly recap objectives. As the name suggests, Short-Term Inflation- Protected Securities Index tracks a por- tion of the Treasury Inflation-Protected Securities (TIPS) market. Holding just 16 bonds, it aims to shadow the Barclays U.S. Treasury Inflation- Protected Securities 0–5 Year Index. The rationale for owning a fund like this is that you get a high-quality port- folio of short-term Treasury bonds, plus protection against inflation. Unique to TIPS, each bond’s principal value is adjusted every six months based on the most recent inflation data. When infla- tion is rising, the principal amount goes up. Because the interest (or coupon) rate remains constant, the income being paid also increases. The idea is that investors’ real returns, or returns above and beyond inflation, should remain constant. The trouble is inflation protection isn’t worth much when there is almost no inflation to contend with. The enor- mous decline in oil prices from over $100 a barrel little more than a year ago has been the leading reason that headline consumer price inflation (CPI) has been flat over the past 12 months. The core CPI, which excludes vola- tile food and energy prices to reflect inflation trends, shows prices increased 1.9% over the past year. If oil just stays at its current price, the gap between headline and core CPI will narrow, but that doesn’t mean inflation is roaring TIPS No Inflated Returns

Money Market ’s fractional 0.1% gain—so it hasn’t cut it as a money- market alternative. It has also failed to provide “protection from inflation” despite the low 5.3% rise in prices (using core CPI) we’ve seen over the past three years. The bottom line is that you would have been better off with any of the other short-term bond sib- lings, including Short-Term Treasury or Short-Term Investment-Grade , up 1.8% and 4.5%, respectively. The one net positive: So far, the fund has outpaced its actively man- aged big brother, as Inflation-Protected Securities is off 6.2% over the past three years. The index fund has also matched its direct ETF competitor, the iShares 0–5 Year TIPS ETF (STIP), step-for-step. So Vanguard’s indexing team hasn’t dropped the ball here. But maybe the best that can be said for Short-Term Inflation-Protected Securities Index is that its relative pros- pects are looking better today than they have at any point since its birth. As I said earlier, insurance against infla- tion is on sale. Additionally, October is the third month in a row that the fund has reported an SEC yield above zero. It’s also the third straight month where its yield has been higher than Prime Money Market’s. Short-Term Inflation Protected Securities Index’s SEC yield of 0.22% is also on par with Inflation Protected Security’s 0.26% yield, despite holding shorter-maturity bonds. What that tells me is that if you are looking for protection from infla- tion, you should lean toward the short- maturity TIPS index fund. Short-Term Inflation-Protected Securities Index has not delivered in its first three years, but it is in a bet- ter place today to serve as a money market alternative over the next three years. Still, for the cash you don’t need immediately, why take the chance on the fund finding its footing when the tried-and-true option of Short-Term Investment-Grade is available? n

Short TIPS Falls Short

1.10

Rising line = Short TIPS is outperforming

1.05

1.00

0.95

Short-Term Treasury Short-Term Investment-Grade Inflation-Protected Securities Prime Money Market Core CPI iShares 0-5 Year TIPS ETF (STIP)

0.90

0.85

0.80

1/13

4/13

7/13

1/14

4/14

7/14

1/15

4/15

7/15

10/12

10/13

10/14

10/15

back—merely that the price of oil is no longer in decline. When considering an inflation fund, pay attention to the spread (or differ- ence) between its current yield and that of a Treasury fund with a similar matu- rity. This spread tells you how much you are paying for that inflation protection. When the spread is small (i.e. the regu- lar Treasury fund’s yield is only slightly higher than the inflation fund’s yield), people don’t expect much inflation down the road, and insurance against inflation is cheap. When the spread is large, people are worried about future inflation and you are paying a premium for that inflation protection. Today the difference in yield between Short-Term Inflation-Protected Securities Index and Short-Term Treasury is 0.28%, or 28 basis points, which is below average and suggests insurance against inflation is on sale. Now let’s get back to the blood- less verdict of the market. In the chart above I’ve plotted the performance of Short-Term Inflation-Protected Securities Index relative to a number of different competitors—both within Vanguard and outside. When the line is rising, Short-Term Inflation-Protected Securities Index is outperforming. As you can see, most of those lines have trended downward. Short-Term Inflation-Protected Securities Index’s 2.4% loss since inception trails Prime

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