Bond Fund Nominal vs Real Average Duration

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palaheel
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Bond Fund Nominal vs Real Average Duration

Post by palaheel »

My MegaCorp 401k has a TIPS unit trust (ER .02%) that religiously tracks BBgBarc US TIPS.

My question is about duration. The unit trust information lists

Avg Duration (Nominal) 5.25 YRS

and

Avg Duration (Real) 7.3 YRS

The Vanguard Inflation-Protected Securities (VAIPX) has

Average duration 7.5 years.

Does the VAIPX Average duration relate to the Nominal or Real duration of the unit trust?

Many thanks.
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lack_ey
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Re: Bond Fund Nominal vs Real Average Duration

Post by lack_ey »

I think that would generally be the real duration (sensitivity to changes in real interest rates) for TIPS funds unless otherwise specified.

The nominal duration for a TIPS fund would have to be estimated or inferred based on past behavior. Or I'm sure there are some papers out there with some methods for that.

Vanguard lists a Bloomberg Barclays TIPS index as a reference for their TIPS fund and list average duration of 7.1 years at the end of Q1:
https://investor.vanguard.com/mutual-fu ... olio/vaipx

So that seems to be confirmation that the durations there are real duration.
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grabiner
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Re: Bond Fund Nominal vs Real Average Duration

Post by grabiner »

The real duration of a TIPS is well-defined, because TIPS yields are quoted in real yields. If a TIPS which is currently trading for $1000 drops in value to $900, and its real yield rises by 1%, this implies that the duration is 10 years.

Nominal duration is an estimate of how TIPS will react if nominal rates change. If expected inflation doesn't change, nominal and real rates should change by the same amount; a TIPS yielding 2% less than a Treasury of the same duration is only an attractive investment to investors who expect inflation to be 2% or more. If expected inflation rises by 1% and nominal rates rise by 1%, this shouldn't affect TIPS at all.

(edited to correct typo)
Last edited by grabiner on Mon Apr 29, 2019 8:43 pm, edited 1 time in total.
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palaheel
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Re: Bond Fund Nominal vs Real Average Duration

Post by palaheel »

Thanks for the education. Bond funds are an area I've got to study more--I'm getting older.
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garlandwhizzer
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Re: Bond Fund Nominal vs Real Average Duration

Post by garlandwhizzer »

grabiner wrote:

a TIPS yielding 2% less than a Treasury of the same duration is only an attractive investment to investors who expect inflation to be 2% or less
Isn't it the other way around? TIPS benefit from unexpected higher inflation due to their inflation adjustment to principal value whereas Treasuries are fixed in yield and don't. In the case above at the time of issuance the market expects 2% inflation as reflected in the different yields of TIPS versus nominals. If inflation turns out to be higher than 2% (unexpected), TIPS benefit because their yield will increase reflecting that increased inflation adjustment whereas Treasury yields, being fixed, will suffer losses in real inflation adjusted terms due to that unexpected inflation. If the above investor expects inflation to be more than the 2% the market has priced in, he might prefer TIPS to Treasuries.

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grabiner
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Re: Bond Fund Nominal vs Real Average Duration

Post by grabiner »

garlandwhizzer wrote: Mon Apr 29, 2019 12:08 pm
grabiner wrote:

a TIPS yielding 2% less than a Treasury of the same duration is only an attractive investment to investors who expect inflation to be 2% or less
Isn't it the other way around?
Yes, and I corrected it above. It should be "2% or more".
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