strong for the case of including TIPS as part of the strategic asset
allocation. In the case of unconstrained optimization, none of the
TIPS had any allocation on the efficient frontier, but neither did
commodities and international stocks. All the efficient portfolios
for Investor A in the unconstrained case included domestic stocks,
bonds, and cash. Half the time the S&P 500 represented the equity
allocation with the rest in small-cap stocks represented by Russell
The lesson for investment consultants and wealth managers is that
TIPS deserve serious consideration in the strategic asset allocation
process. The Sharpe ratio maximizing optimization resulted in an
annualized return of 8. 2 percent, which is close to the target rate
for most institutional investors to stay solvent.
Kurtay Ogunc, PhD, is an instructor of finance in the E. J. Ourso
College of Business, Louisiana State University. Contact him at
Asli Ogunc, PhD, is an associate professor of economics in the
department of economics and finance at Texas A&M University–
Commerce. Contact her at firstname.lastname@example.org.
This study was funded by a grant from IMCA®.
1. As of November 2016, the total outstanding TIPS debt is $1,231.4 billion (a total of
forty). Since March 2015, four more issues matured and five new TIPS were issued.
Since TIPS were first introduced in 1997 until November 2016, the government issued
a total sixty-one securities, twenty-one of which matured.
2. Re-opening refers to the additional issuance of an outstanding security.
3. At the time the U.S. Department of the Treasury felt strongly that it could lower
its borrowing costs by issuing debt in the short end of the Treasury curve at much
4. The way to avoid the tax consequence is to own the inflation-indexed securities in a
tax-deferred retirement savings account.
5. Youngdahl et al. (2001) states that TIPS have been a very expensive borrowing
mechanism, with break-even inflation rates relative to nominal issues that have run
consistently well below actual inflation since the global financial crisis of 1998.
6. Ellen Safir (2002) of New Century Advisors designed a leveraged TIPS product that is
leveraged 2: 1 with the volatility approximating that of the nominal bonds because real
interest rates are half as volatile as nominal rates. Safir had correctly postulated that
the active management of leverage adds value in the case of indexed bonds. Looking
at the time-series behavior of many issues of TIPS, we can conclude that they
definitely possess the characteristics of a trending series, lasting for about four to five
years. Around the same time, we had argued that a leveraged TIPS product had a
much better risk/return profile than a diversified fund of hedge funds for institutional
investors. Ex post, we were both proven right.
7. A portfolio that sells short the conventional and purchases the indexed bond embod-ies only the inflation risk, and it acts like a synthetic asset that is not exposed to the
risk arising from the changes of real rates.
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