Real Return Bonds

[Shakespeare]

I'm holding what RRB's I have - about 11% of my portfolio - but not currently adding RRBs. I have, however, purchased US TIPs (via the TIP ETF) to about 6-7%.

[BCJohn]

Thanks, Shakes. I guess my question is: If you didn't currently have any RRBs or XRB but believed you wanted to include them in your portfolio, would you be buying at today's yields/prices? Or when would you be willing to add to your holdings?

[Shakespeare]

I would wait for >2% real yield before adding. YMMV.

[ghariton]

I would wait for >2% real yield before adding. YMMV.

Even I'm waiting. I'm deviating from plan, and engaging in market timing, and I'll probably regret this. But I do expect a short term uptick in real rates (overshoot) once the Bank of Canada increases its rate some more. And why would they do that? Well, first-quarter GDP growth came in at 3.8% (subject to revisions, of course). I would expect some inflation soon, if I were the bank.

Georges

[ockham]

I need help with the arithmetic of RRBs.

On Jan10/06 I bought 16,000 of GOC 4.25% 2026 RRBs at 183.647, for a total cost of $29481.92 inclusive of $98.40 interest. The index ratio on settlement date of Jan13 was 1.22841. I was quoted a real yield of 1.484% by BMOIL.

On June 1/06, the index ratio was 1.23717. The interest payment on June 1/06 I expected was one-half of 4.25% of $16000 * 1.23717, or $420.64. (The accrued interest included in the purchase price was consistent with this expectation). But the interest payment I in fact received was $340, which is just one-half of 4.25% of $16000.

Do I just not get it? or will there be a supplemental interest payment? or is the index adjusted interest payment made only annually? or .... ? I'd appreciate some help understanding this.

[Bylo Selhi]

I need help with the arithmetic of RRBs.

I think it's BMO who needs help with the arithmetic of RRBs.

Perhaps you could refer them to this

Q. How do I determine the value of an interest payment?
A. All series of RRBs pay interest on June 1st and December 1st. For every $1,000 face value you'll receive an interest payment of $1,000 times half the coupon rate (e.g. 0.0425/2) times the then current index ratio.

FWIW TD WH got my and my wife's RRB interest payments correct up to the penultimate penny. (I assume their system truncates rather than rounds up. Perhaps someone in their IT department is really cleaning up on this

(There's a story, perhaps apocryphal, about the bank computer programmer who fudged interest calculations to direct fractional cents to his personal account. The auditors were slow to notice because everything balanced, but with "billions and billions" of transactions those pennies added up to real money real fast.))

[ockham]

Thank you, Bylo. I will take this up with BMOIL tomorrow, during "regular" business hours. We'll see what they say.

[George$]

... I have, however, purchased US TIPs (via the TIP ETF) to about 6-7%.

Shakes: I thought TIPS yields were no better than RRBs. I must be wrong. Care to explain a bit your move to US TIPS?

[jiHymas]

Thanks, Shakes. I guess my question is: If you didn't currently have any RRBs or XRB but believed you wanted to include them in your portfolio, would you be buying at today's yields/prices? Or when would you be willing to add to your holdings?

Figure 2 of RECENT AND PROSPECTIVE TRENDS IN REAL LONG-TERM INTEREST RATES: FISCAL POLICY AND OTHER DRIVERS (page 31 of the PDF) may be of interest.

[Shakespeare]

I thought TIPS yields were no better than RRBs

From Bloomberg:

Code: Select all

Inflation Indexed Treasury
        COUPON   MAT.DATE   CURRENT        CHANGE         TIME
5-Year   2.375   04/15/2011   100-21/2.23   0-14/-.099   06/02
10-Year   2.000   01/15/2016   96-28/2.36   0-22/-.084   06/02
20-Year   2.000   01/15/2026   93-22/2.40   1-03/-.074   06/02
30-Year   3.375   04/15/2032   121-08/2.28   1-18/-.073   06/02

TIPS are yielding 2.3% vs RRBs 1.8%.

Care to explain a bit your move to US TIPS?

See this thread.

[Bylo Selhi]

Thank you, Bylo. I will take this up with BMOIL tomorrow, during "regular" business hours. We'll see what they say.

BTW, in the (rather unlikely IMO) event that BMOIL doesn't accept Bylo's arithmetic, you could always point them to the official Bank of Canada prospectus [PDF]. The bottom of page 2 and the first part of page 3 agree with Bylo's arithmetic once you simplify the bureaucrats' algebra

[ockham]

The BMOIL representative checked with their bond desk and then reported to me that the bond desk was already aware that they had made a mistake, and would be posting the appropriate credit to my account within the next day or two. So this appears to be heading to a happy ending.

[ghariton]

Yields on July 11, as shown in today's Globe and Mail, range from 1.78% to 1.83%.

I note that (1) the yield curve has been flat for a long time -- is any meaning to be attached to that? (2) the uptick in yields that I expected hasn't happened yet -- and thanks to Dodge's recent anouncement, is now unlikely.

Time for me to buy (only six weeks off my plan).

Georges

[adrian2]

Yields on July 11, as shown in today's Globe and Mail, range from 1.78% to 1.83%.

I note that (1) the yield curve has been flat for a long time -- is any meaning to be attached to that? (2) the uptick in yields that I expected hasn't happened yet -- and thanks to Dodge's recent anouncement, is now unlikely.

OTOH, US yields are significantly higher than they were not so long ago - around 2.5%, also with a flat yield curve.

You may want to consider allocating some buys to the US side.

[ghariton]

You may want to consider allocating some buys to the US side.

Thanks, Adrian.

Yes, I do maintain a balance between RRBs and TIPs.

Georges

[ghariton]

Yielding between 1.77 and 1.80, according to today's Globe & Mail.

(The volatility and ensuing excitement are killing me. )

Georges

[Bylo Selhi]

Scott Burns on Treasury Inflation Protected Securities

TIPS, otherwise known as Treasury Inflation Protected Securities, have taken some hard knocks this year. Many investors are surprised at the losses. They may have believed having inflation protection is the same as being invulnerable. It isn't... Query: Should we reconsider our enthusiasm for inflation-protected securities? Answer: I don't think so. Here are three good reasons to favor them.

1. Inflation is the primary enemy of fixed-income investments.
2. Investors tend to underestimate inflation.
3. Investing is about purchasing power.

[ghariton]

Scott Burns on Treasury Inflation Protected Securities

From the article:

I visited the Federal Reserve Web site and downloaded its data on both the traditional five-year constant maturity index and the five-year TIPS constant maturity index.

When I added the trailing 12-month inflation rate to the TIPS yield, I found the TIPS yield, looking backward, was usually superior to the five-year note rate.

In the 42 monthly periods from January 2003 through June 2006, the TIPS index plus inflation beat the nominal Treasury yield 36 times.

The average advantage was 0.66 percentage points.

Is that conclusive evidence? No, it's just an indication.

I must say I'm pleasantly surprised. I'm prepared to earn about half a percentage less on indexed bonds than on nominal bonds. After all, I've just shifted the risk of unexpected inflation to someone else. But not only do TIPS not require the investor to pay a premium, they actually have given a better return!!

But I note the last sentence of the quote.

Georges

[big easy]

Sorry if the question has already been posted but.. What if there is negative inflation? What happens to the interest rate? Is it reduced by the rate of deflation?

[ghariton]

Sorry if the question has already been posted but.. What if there is negative inflation? What happens to the interest rate? Is it reduced by the rate of deflation?

In Canada, the interest and redemption value of an RRB would decline if there were deflation (a most unlikely event, in my opinion). By contrast, in the U.S., the equivalent product, TIPS, has an interest payment and a redemption value on maturity that go up with inflation, but do not go down with deflation.

See here for more details.

Georges

[Norbert Schlenker]

By contrast, in the U.S., the equivalent product, TIPS, has an interest payment and a redemption value on maturity that go up with inflation, but do not go down with deflation.

Not so. Quoting from the Bureau of Public Debt's website ...

The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater.

TIPS pay interest twice a year, at a fixed rate. The rate is applied to the adjusted principal; so, like the principal, interest payments rise with inflation and fall with deflation.

The bolded words indicate that TIPS are no different from RRBs when it comes to declines in both interest and principal in case of deflation. The only difference between RRBs and TIPS under deflation is in the underlined sentence. TIPS cannot mature at less than a nominal 100; RRBs can.

[ghariton]

Oops. Thanks, Norbert!!

Georges

[big easy]

In 1996 the yield hit 5%. So current yields seem unattractive. Is anyone aware of a correlation between the RRB yield and inflation or other measure ? What would be an reasonable historical yield at which to buy an RRB?

Its an interesting idea to buy these as a sort of inflation protected annuity. Would one buy them at retirement or now with a maturity set to age 100 or something?

Thanks for the previous info.

[MaxFax]

The info you want is on the graph :
http://members.shaw.ca/RetailInvestor/RRBond.xls

[Cheryl]

Pardon these silly questions from a mathematically-challenged novice investor, but I need some help. I want to add to the fixed income portion (currently mainly XSB and XBB) of my portfolio (in the accumulation stage). So, I was thinking of XRB. A lot of posts have said buying RRBs directly is better than XRB unless the amt is fairly small. How small is small? Anything under $5,000...$50,000... $100,000?

MERs on RRB funds are ridiculous and as I'm currently with BMOIL, TD's e-funds are out. That leaves me with bond index funds (MERs of approx .95) or XRB (commission and XRB's .35 makes payback time less than a year). Which is why I was leaning towards XRB. But how do I calculate real yield? Trying to wrap my head around RRBs with Bylo/Shakes' sites and the various posts here, it seems XRB's div includes a CPI component - how does one calculate it? At current prices of around $19.55, yield works out to ~2.35. How much of that is real yield?
Page 2 of iShares Fact sheet (http://www.ishares.ca/publish/content/r ... XRB_EN.pdf) mentions an Index YTM of 1.46 and a unit value of $18.93. Is that it at that unit value? I emailed iShares and haven't heard back yet; called the toll free # and twice reps have promised to get back but haven't - yet. Should I just stick with a bond index fund ??
Thanks for your help! C.