WHY TIPS? They Don’t Hedge Pension Inflation!

Ryan ALM has written a lot on the subject of pension inflation and why it doesn’t make sense to have an allocation to TIPS in your pension plan since they don’t hedge pension inflation. Our extensive research on this subject can be found at Ryan ALM.com. That said, I wanted to highlight why in this environment it makes absolutely no sense to have an allocation to TIPS. Presently, TIPS at all maturities are offering a negative yield. For the 30-year maturity the yield is -0.36%. So, a plan is paying to own these bonds, as opposed to owning an investment grade corporate credit (BBB) that would pay roughly 3.11%, which is based on our universe of BBB bonds with maturities between 28-30 years.

Steve DeVito, Ryan ALM’s Head Trader, stated “it’s a gamble that inflation will rise significantly enough to provide a positive yield.” Furthermore, “after X number of years earning a negative yield how big of a positive yield and for how many years will an investor need to make up for lost income and do better than just breakeven?” Good question, Steve!

We’ve written a lot on the subject of maximizing the efficiency of the plan’s asset allocation. In all honesty, there is nothing efficient in allocating <3% to any strategy and thinking that it will provide value-added to 100% of a pension plan. In the case of TIPS, a <3% allocation is just creating opportunity cost, while becoming a drag on achieving the ROA or any other goal for that matter.

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