I was looking at the recent performance of the Vanguard Inflation-Protected Securities Fund (VIPSX). In the period from September 30, 2016 until June 30, 2017, VIPSX went from 13.79 to 13.07 - a drop of about 5%.

VIPSX chart

(Source: Ameritrade Historical Quotes).

According to the US Bureau of Labor and Statistics, the CPI for the same period is about 1.3% (that is, $10,000 in October 2016 has the same buying power as $10,133 in June 2017).

That's not how I understand "inflation protection" - obviously there is something that I am missing.

Can somebody please explain why there can be such a divergence between these two quantities, when one is supposed to track the other? I imagine that interest rates play into this (as interest rates rise, other investments may be more attractive?) - but I've not been able to find a really good explanation, given the fund's stated goal:

Vanguard Inflation-Protected Securities Fund seeks to provide investors inflation protection and income consistent with investment in inflation-indexed securities.

A 6% divergence from the goal in a "conservative" fund looks like a big miss to me. If I wanted that kind of risk to my capital, I'd put it somewhere that has a greater potential reward...

It seems this is not the only "inflation protected" security to suffer this fate. The iShares TIP chart for the last year looks like this:

enter image description here

Again - we see a big drop starting right after the US presidential election (is that a clue?), reaching a minimum on December 16th before recovering somewhat. NAV return for the last year is about -1.55%.

And that's a fund that claims to be 100% invested in US government TIPS... What am I missing?

  • 2
    What leads you to believe this fund should track the general CPI? Does the chart you've provided include dividends?
    – quid
    Jul 14, 2017 at 22:09
  • @quid It is being offered as the "Inflation Protected Securities Portfolio" option in my state's 529 plan. I assumed such securities would attempt to track the CPI - hence the name. Clearly, this is not what this fund is doing - a drop of 6 % relative to inflation is hardly "protection". Are there other, similar, investment options that do this better?
    – Floris
    Jul 14, 2017 at 22:15
  • Looking at some other TIPS funds, eg this one shows the same trend: all these funds seem to have taken a big hit towards the end of last year (and that's a "total returns" chart). So the question stands - why did "TIPS funds in general" have a decline at the end of last year when inflation clearly didn't turn negative?
    – Floris
    Jul 14, 2017 at 22:31
  • What were fund dividends over the same duration as the share price decrease?
    – user662852
    Jul 15, 2017 at 19:16
  • @user662852 2.05% in December, according to this answer. Not enough to explain the difference. Based on the answers that were given, I now understand that the reason is: "because this fund tracks CPI through the use of bonds, the value is affected by interest rates and sentiment". In the short term that will cause significant deviations from the CPI - in the long term, it should get close to protecting against inflation."
    – Floris
    Jul 16, 2017 at 13:39

2 Answers 2


Unfortunately, it's not the case that a portfolio that invests in inflation-linked bonds will actually track the underlying inflation index. The only thing such a portfolio can do is to insulate you against unexpected changes in inflation over the maturity of the bonds they invest in.

Although the actual payments from the bond will be linked to the inflation rate, the initial cost of the bond will depend on market conditions at the time.

To simplify, consider a single inflation-linked bond, alongside a regular bond from the same issuer with the same maturity (say 5 years).

The prices of the two will be linked by what the market expects inflation to be over that 5 year period. For example, suppose the market expects inflation to be a constant 2% over that period, and the regular bond currently has a yield of 3% (the "nominal interest rate"). Then at the start of that period the inflation-linked bond will have a yield of 1% (+inflation). So you'll do a bit better than inflation, and if it unexpectedly rises to say 4%, you'll get 5% instead of 3%.

But now suppose inflation expectations were already 4% when buying the bond. Then the yield of the inflation-linked bond will be -1% + inflation, i.e. you'll end up making less than inflation.

To repeat, the "real" rate of income you can expect on an inflation-linked bond is (nominal interest rates - inflation expectations), both at the time of purchase. This can obviously vary quite a lot and might be more than 0 or less than 0, but at least you do get to lock in that inflation-linked return until the bond expires.

The second complication is what happens if you sell the inflation-linked bond before maturity. The appropriate price for that bond will again depend on the current real return - (nominal interest rates - inflation expectations) - this time measured at the point you sell it. If that number has gone up, e.g. nominal rates have increased, or inflation expectations have decreased, then because your bond has a lower locked-in rate, its value will have gone down. Likewise if real returns have gone down, your bond is now worth more.

So a fund or index that invests in lots of inflation-linked bonds over time will end up with income that might be more or less than inflation, and also at any given time if you calculate the value of the fund if sold now, it might have changed quite a lot because of fluctuations in nominal interest rates. At any given time, if inflation expectations suddenly jump, your fund should also jump. But over the long-term, as it reinvests, it won't be able to track inflation.

  • Does this mean that the drop at the end of last year suggests that "the market" thought inflation would be going DOWN (it was already quite low...)? Just when the newly elected president was claiming he would borrow a lot of money for infrastructure projects (which would likely drive inflation UP?). Sorry - I'm still a bit confused by what you are saying.
    – Floris
    Jul 14, 2017 at 22:51
  • 2
    @Floris: I didn't try to analyse the specific performance change for your scenario - perhaps interest rates were going up, or inflation expectations going down. Jul 15, 2017 at 9:00

From the Vanguard fund prospectus the goal of the fund is:

The Fund seeks to provide inflation protection and income consistent with investment in inflation-indexed securities.

The fund seeks to invest in inflation protected securities, which it defines in the statement of information as:

Inflation-indexed securities are debt securities, the principal value of which is periodically adjusted to reflect the rate of inflation as indicated by the Consumer Price Index (CPI).

This fund buys securities that have a variable coupon rate that is adjusted based on inflation. It is not, in and of itself, de-facto inflation protection. This fund does not seek to track the CPI specifically the way an S&P 500 Index fund specifically seeks to track the returns of the S&P 500 Index. This is simply a bond fund that buys bonds with inflation adjusted coupons, it seeks to track the performance of the market for inflation-indexed securities.

From the panel at my brokerage it seems this fund's top 10 holdings are:

    Description       % Holdings                 Maturity   Coupon
--  US Treasury Note    5.38%   1.4B    $1.4B   04/15/2019  0.13%
--  US Treasury Note    5.18%   1.3B    $1.4B   04/15/2018  0.13%
--  US Treasury Note    4.60%   1.2B    $1.2B   04/15/2020  0.13%
--  US Treasury Note    4.12%   1.1B    $1.1B   01/15/2027  0.38%
--  US Treasury Note    3.95%   1.0B    $1.1B   04/15/2021  0.13%
--  US Treasury Note    3.93%   1.0B    $1.1B   07/15/2024  0.13%
--  US Treasury Note    3.82%   962.0M  $1.0B   07/15/2022  0.13%
--  US Treasury TIP     3.82%   971.3M  $1.0B   01/15/2023  0.13%
--  US Treasury Note    3.79%   951.3M  $1.0B   01/15/2024  0.63%
--  US Treasury Note    3.79%   937.7M  $1.0B   01/15/2022  0.13%

This fund is subject to the same general movements of the bond sector. If interest rates move that changes demand for bonds. I'm not going to speculate on the exact event toward the end of last year but it seems some event occurred which impacted the value of inflation adjusted U.S. government debt en-masse.

Additionally, dividends and other distributions need to be considered when addressing fund performance over time. Since Sept 30, 2016, this fund has paid:

                               Short  Long  Return   Total
Date          NAV    Dividend  Term   Term     of    Distribution
                               Gain   Gain  Capital
06/22/2017  13.1600   0.0140    --      --      --  0.0140
03/28/2017  13.1200   0.0110    --      --      --  0.0110
12/23/2016  12.9100   0.2642    --  0.0170  0.1548  0.4360

If these amounts were reinvested your single unit in the fund would now be about 1.0357 units. This still results in a slight decrease, but again, that is because this fund seeks to hold securities that are indexed to the CPI, it does not seek to actually track the CPI.

One benefit of investing in funds is that people with smaller holdings can diversify against a batch of securities they could not buy on their own. If you were seeking to buy inflation protected government bonds it would take much, much more than the $13 this fund currently trades for. This is an investment for people who want to invest in "inflation-indexed securities" like the ones held by this fund and either can't do it on their own, or would rather pay the reasonable 0.20% expense fee to let someone take care of the management.

So to answer your question of why this fund doesn't match the change in the CPI, because it's not supposed to.

  • IOW, TIPS funds can only protect against "Inflation risk", not general "Interest rate risk".
    – RonJohn
    Jun 6, 2021 at 23:54

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