Why isn't VIPSX an index fund?

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simplesimon
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Why isn't VIPSX an index fund?

Post by simplesimon »

A post in another thread prompted me to think about this. There was a growth chart comparing 4 or 5 TIPS funds/ETFs and I thought to myself, "VIPSX is acting awfully like an index fund (in that its keeping very close track with the ETF TIP), but it isn't one"...at least not by Vanguard's standard of allowing $10k minimums for its admiral share class.

What's up with that?
Chuck
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Post by Chuck »

I'm just guessing, but maybe the TIPS market doesn't have enough liquidity. That was the excuse for the pricing issues in 2008, right? That kind of market might require more patient buying and selling than an index fund can afford.

Don't hold me to it. Like I said, I'm just guessing.

Maybe management thinks they can add value by managing the maturity more carefully. If the major buyers of TIPS are institutional (endowments, insurance companies, etc.) it may skew the index to a longer duration than the typical retail investor wants. So there's another guess.
exeunt
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Post by exeunt »

Chuck's guess is right. Vanguard has a history of creating actively managed funds for less liquid markets before rolling out an index-fund flavor.
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Doc
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Post by Doc »

With a universe that only contains a few handfuls of issues liqudity should not be an issue. You just buy new issues and hold to maturity.

I believe no Vanguard Treasury funds are indexed. Realistically if you wanted a Treasury portfolio that replicated the index you just buy the issues yourself and save the e/r. For the fund to attract capital it must at least recover its e/r and therefore it has to do some active management.

A Treasury index fund would have appeal that may be limited to only investors with portfolios to small to buy Treasuries directly.
mamster
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Post by mamster »

Doc, I don't think that's the case, since there are many treasury funds that--as far as I now--are 100% passively indexed, such as the iShares ETFs and Fidelity Spartan funds. The ERs on these funds are low enough that for many people it's not worth bothering to buy individual bonds versus holding the index.

I own quite a bit of VIPSX, and I too wonder why it's actively managed. I have a guy at Vanguard I can ask; I'll let you know what he says.

Best,
Matthew
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Doc
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Post by Doc »

mamster wrote:Doc, I don't think that's the case, since there are many treasury funds that--as far as I now--are 100% passively indexed, such as the iShares ETFs and Fidelity Spartan funds. The ERs on these funds are low enough that for many people it's not worth bothering to buy individual bonds versus holding the index.

I own quite a bit of VIPSX, and I too wonder why it's actively managed. I have a guy at Vanguard I can ask; I'll let you know what he says.

Best,
Matthew
Strategy & Objective (FIBIX)
Strategy Press CTRL + Enter to view help
Normally investing at least 80% of assets in securities included in the Barclays Capital 5-10 Year U.S. Treasury Index. Normally maintaining a dollar-weighted average maturity of three to 10 years. Engaging in transactions that have a leveraging effect on the fund.
http://fundresearch.fidelity.com/mutual ... /315911842
The iShares Barclays 3-7 Year Treasury Bond Fund seeks results that correspond generally to the price and yield performance, before fees and expense of the intermediate sector of the United States Treasury market as defined by the Barclays Capital U.S. 3-7 Year Treasury Bond Index.
http://us.ishares.com/product_info/fund ... ew/IEI.htm

This makes us both half right so together we're perfect. :wink:

I would be very suprised if you get a definitive answer from Vg but I am very interested.
mamster
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Post by mamster »

My Vanguard PR guy is on vacation until May 5. :( But I suspect he'll write back when he gets back.

Thanks for schooling me on the Fidelity fund. Half-right works for me.
stlutz
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Post by stlutz »

Vanguard's Treasury funds tend to maintain a lower duration than their similar indexed counterparts. The management of them tends to be very consistent (management only makes small bets, not big ones). Converting them to indexed funds would make them riskier than existing shareholders have come to expect from these funds.

On TIPS specifically, a manager can fairly easily add value by determining whether to buy off/on-the run or securities at auction--this market is not as efficient as you might guess. Note that this does not involve making duration bets--it's just like deciding that if one gas station has regular at $3.85 and the one across the street is at $3.83, you'll go across the street.
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simplesimon
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Post by simplesimon »

mamster, I'd be interested in hearing what your friend has to say.
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Doc
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Post by Doc »

stlutz wrote: On TIPS specifically, a manager can fairly easily add value by determining whether to buy off/on-the run or securities at auction--this market is not as efficient as you might guess. Note that this does not involve making duration bets--it's just like deciding that if one gas station has regular at $3.85 and the one across the street is at $3.83, you'll go across the street.
That is a very good point. It is something I am aware of in maintaining my own TIPS ladder but I completely forgot it when it came to funds. Chalk it up to a senior moment. :(
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stratton
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Post by stratton »

Doc wrote:
stlutz wrote: On TIPS specifically, a manager can fairly easily add value by determining whether to buy off/on-the run or securities at auction--this market is not as efficient as you might guess. Note that this does not involve making duration bets--it's just like deciding that if one gas station has regular at $3.85 and the one across the street is at $3.83, you'll go across the street.
That is a very good point. It is something I am aware of in maintaining my own TIPS ladder but I completely forgot it when it came to funds. Chalk it up to a senior moment. :(
I've seen off-the-run and on-the-run differences as big as 25 or 30 basis points on 20 year TIPS. If my IPS says buy 20 year TIPS I'll ignore it if 19 or 21 year ones are yielding 0.25% higher.

Paul
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Doc
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Post by Doc »

stratton wrote:
Doc wrote:
stlutz wrote: On TIPS specifically, a manager can fairly easily add value by determining whether to buy off/on-the run or securities at auction--this market is not as efficient as you might guess. Note that this does not involve making duration bets--it's just like deciding that if one gas station has regular at $3.85 and the one across the street is at $3.83, you'll go across the street.
That is a very good point. It is something I am aware of in maintaining my own TIPS ladder but I completely forgot it when it came to funds. Chalk it up to a senior moment. :(
I've seen off-the-run and on-the-run differences as big as 25 or 30 basis points on 20 year TIPS. If my IPS says buy 20 year TIPS I'll ignore it if 19 or 21 year ones are yielding 0.25% higher.

Paul
I just looked at some data I gathered on the ten auction in January and the on the run effect wasn't apparent but it certainly was there in '08. But IIRC the numbers you cite are not inconsistant with what was happening then.
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Post by mamster »

Here's the word from Joshua Grandy at Vanguard. Let me know if you have followup questions (mine is: if the treasury funds already hold up to 20% agency debt, isn't that nearly total overlap with the government index funds?):

"Our Treasury Funds have been around for nearly 20 years. As they're very risk-controlled, there would be little difference between our active Treasury Funds and a straight passive version. Additionally, there would be little cost savings between passive and active products.

"As you may know, we recently launched passive government bond funds in short-, intermediate, and long-term slices for those investors who want an index or ETF option. These government index funds vary in their Treasury exposure from 75-93%, with the balance being agency debt. Passive Treasury index funds would have a high degree of overlap with our government index funds, so we didn't think it was worthwhile to have two sets of passive products that were so close to one another."

Best,
Matthew
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Post by Doc »

mamster wrote:Here's the word from Joshua Grandy at Vanguard. Let me know if you have followup questions (mine is: if the treasury funds already hold up to 20% agency debt, isn't that nearly total overlap with the government index funds?):

"Our Treasury Funds have been around for nearly 20 years. As they're very risk-controlled, there would be little difference between our active Treasury Funds and a straight passive version. Additionally, there would be little cost savings between passive and active products.

"As you may know, we recently launched passive government bond funds in short-, intermediate, and long-term slices for those investors who want an index or ETF option. These government index funds vary in their Treasury exposure from 75-93%, with the balance being agency debt. Passive Treasury index funds would have a high degree of overlap with our government index funds, so we didn't think it was worthwhile to have two sets of passive products that were so close to one another."

Best,
Matthew
He left out and "goosing our yield a little". :wink:
retiredjg
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Post by retiredjg »

Why isn't VIPSX an index fund?
To have an index fund there has to be an index. Does a TIPS index exist?
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Post by smathew005 »

retiredjg wrote:
Why isn't VIPSX an index fund?
To have an index fund there has to be an index. Does a TIPS index exist?
Yes there are a few indices that track the US inflation indexed bond market.

Barclays Capital U.S. Treasury Inflation Protected Securities (TIPS) Index (Series-L) is the most widely followed index.

I have yet to understand what the "Series-L" means.
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Post by mamster »

Doc wrote:He left out and "goosing our yield a little". :wink:
I pressed him on this and he basically admitted it.
Joshua Grandy, Vanguard wrote:The Short-, Intermediate, and Long-Term Treasury Funds' Investment Strategy states it they must invest at least 80% of its assets in U.S. Treasury securities, including TIPS. The other 20% may be invested in other securities that are backed by the U.S. or are U.S. agencies, such as agency (FNMA, GNMA, FHLMC) debt and agency mortgage-backed securities. The Fund has the ability to use this 20% bucket as an opportunity to add value in a risk-controlled fashion. During the first quarter, the Fund invested 15% in mortgage-backed securities due to their attractive risk/reward characteristics relative to nominal Treasuries. There were other points in the last couple of years in which we used a portion of the 20% bucket to purchase MBS and agency debt.

The TIPS fund also has a 20% bucket that it can invest in nominal bonds and other debt instruments per its investment strategy, but the fund tends to hem much closer to the benchmark given its inflation-protection goal.
I'm a little puzzled. Do people buy a fund labeled "treasury" and expect it to outperform treasurys? I guess they must.
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Post by retiredjg »

smathew005 wrote:Barclays Capital U.S. Treasury Inflation Protected Securities (TIPS) Index (Series-L) is the most widely followed index.
I would have guessed that VG would follow it. Guess not. Seems a little odd to me.
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Post by Doc »

mamster wrote:I'm a little puzzled. Do people buy a fund labeled "treasury" and expect it to outperform treasurys? I guess they must.
Maybe not but the Morningstar category is short/medium/long government not Treasury. So a Treasury fund often gets compared to funds that invest in government securities like agency notes, GNMA and more recently Fannie Mae and Freddie Mac all of which have somewhat higher yields than true Treasuries for a number of reasons.

Remember also that a 100% Treasury portfolio, unlike more risky securities, can be put together as a ladder at very low cost. Even for modest portfolios at a cost less than the e/r of a fund. People will pay something for the convenience of a fund but that only goes so far. If the fund can juice up there yield by adding a few relatively safe forays into other government guaranteed obligations they can get some of those customers that they would otherwise lose because of the e/r.
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Post by mamster »

Good point about the Morningstar category.

I'm still not persuaded, however, that investors won't pay for the convenience of a fund. Look at TLT, for example. It's 100% nominal treasurys (okay, it holds 0.03% cash), which anyone could easily buy themselves, but somebody ($3 billion worth of somebodies) is buying TLT instead at 0.15% ER. Why?

Not that I'm worried about Vanguard's treasury funds; I assume they'll continue to perform as expected despite occasionally having some unexpected things in the box.
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Post by chipmonk »

smathew005 wrote:
retiredjg wrote:
Why isn't VIPSX an index fund?
To have an index fund there has to be an index. Does a TIPS index exist?
Yes there are a few indices that track the US inflation indexed bond market.

Barclays Capital U.S. Treasury Inflation Protected Securities (TIPS) Index (Series-L) is the most widely followed index.

I have yet to understand what the "Series-L" means.
Sorry to bump this old thread but...

I've been wondering about why Vanguard's TIPS funds aren't indexed, and what the TIPS indexes really *mean* in this case. I hold VIPIX (institutional shares) in my 401k, and they have lagged the Barclay's US Treasury Inflation-Protected Index by 30-50 bp, despite an expense ratio of only 7 bp.

I thought a TIPS index fund might do better, and looked at the chart for TIP (ER of 0.20%), which is supposed to track the same index. TIP does beat VIPIX with an annualized return of 7.20% vs. 7.10% over 5 years, and beats investor-class VIPSX even more (7.20% vs. 6.96% over 5 years).

So it looks like Vanguard's TIPS fund is persistently underperforming relative to actual index funds.

Also, according to Morningstar TIP has an average duration of 3.56 years, compared to 4.95 years for Vanguard's TIPS funds. Is Vanguard intentionally deviating from the duration of the index? Why?
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Post by tripleb »

Doc wrote:With a universe that only contains a few handfuls of issues liqudity should not be an issue. You just buy new issues and hold to maturity.
What should the fund manager do is 20% of the investors decide to pull out one day? Tell the investors, "sorry but I am holding all these issues to maturity. Ask to redeem again in 22 years."
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Post by archbish99 »

The other thing that complicates a TIPS fund is the "phantom income" issue. Remember that if you hold TIPS in a taxable account, you get to pay taxes on the inflation adjustment even though the money is still locked in the bond? A TIPS fund is required to distribute that as a dividend, even though it's still locked in the bonds they hold.

I remember an interview with a TIPS fund manager saying that the impact of that on the fund is minimized when people reinvest dividends (meaning the fund can just keep the distribution locked up), but that they have to either keep cash or liquidate holdings to pay the dividends of those who don't reinvest. I'm sure that generates something of a cash drag.
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