The Calafia Beach Pundit has an interesting discussion on TIPS (inflation-linked bonds). What caught my eye was a nice chart of historical TIPS real (after-inflation) yields vs. Treasury nominal yields. The difference is what inflation would have to be for them to pay out the same total yield, called the “breakeven inflation rate”. If actual inflation is lower, then Treasury bonds end up paying more. If actual inflation is higher, then TIPS pay more. (I’m not really sure why the breakeven inflation rate is on a different scale.)

It’s interesting how relatively steady the breakeven inflation rate has been. The low breakeven inflation rate back in 2009 was a good time to stock up on TIPS. Today, the expected inflation is about the same as historical average but real yields are at historical lows. He concludes:

To sum up: TIPS are only attractive to an investor who believes 1) that inflation will prove to be higher than expected, and 2) that economic growth will continue to be disappointing.

I’m still holding a position in TIPS in my portfolio asset allocation. I have historically overweighted them with high real rates, and today I am slightly underweighting them due to low real rates. They’ve done their job though, helping keep me off the Pepto Bismol during these last few years.

Vanguard has announced that the Vanguard Emerging Markets Stock Index mutual fund (VEIEX) will no longer have a purchase and redemption fee of 0.25%, effectively immediately. Although not huge, this fee was rather annoying and a major reason for many investors (including me) to buy the ETF version VWO instead. It’s good to see that Vanguard is continuing to pass on lower expenses when possible. There is still a 2% short-term redemption fee to discourage frequent trading.

We’re eliminating the 0.25% fee on all purchases and redemptions of Vanguard Emerging Markets Stock Index Fund. The fees had been in place to offset the higher trading costs associated with foreign and illiquid markets. As the fund has matured, and with cash flow in and out of the fund offsetting much of these costs, we no longer need to assess these fees.

The fund is adopting the short-term trading fee that applies to most of our other international funds. To deter costly short-term trading activity, Vanguard assesses a 2% fee on shares redeemed within two months of purchase. Because the fee is paid directly to the fund, it’s not a load.

The Investor shares of the fund ($3,000 minimum) have an expense ratio of 0.33%, but the ETF and Admiral shares ($10,000 minimum) both have expense ratios of 0.20%. If you have enough fund to qualify for Admiral shares, my slight personal preference is the mutual fund as I have no desire to trade intra-day and I like the ease of dollar-based transactions. If I want to by $500 of the fund, I can buy exactly $500 of the fund without worrying about partial shares, limit orders, or bid/ask spreads.

Now, what to do with my existing shares of VWO? You can’t convert ETF shares into mutual fund shares, unfortunately. My initial action will probably be to stop future purchases of VWO while keeping the old shares, and use new incoming cashflow to buy VEIEX. Once I reach $10,000, I will convert automatically (and seamlessly) to the Admiral shares (VEMAX) and stick with that. In the future, if I have to sell some Emerging Markets when rebalancing asset allocations, perhaps I’ll sell the VWO. Or I’ll sell the VWO if there is another market drop and can reduce any capital gains hit.

You can buy and sell all Vanguard mutual funds and ETFs without a commission with an account directly at Vanguard. 32 Vanguard ETFs, including the Emerging Markets ETF VWO, are available commission-free at TD Ameritrade.

The Credit Suisse Global Investment Returns Yearbook 2012 (pdf) provides an analysis of returns from 19 major developed countries from 1900-2011. An article inside called The Real Value of Money by Elroy Dimson, Paul Marsh, and Mike Staunton of the London Business School explores how different asset classes respond to various levels of inflation and deflation.

The table below taken from the article summarizes the long-run performance and inflation sensitivity of those assets for which there is a full 112-year return history available. Note that real returns, or returns in excess of inflation, are used instead of nominal returns.

Equities. Represented by a US dollar-denominated world index, equities had the highest annualized real return of 5.4% but also the highest standard deviation. Stocks were moderately affected by inflation overall, but did not do well in periods of extremely high inflation.

Bonds and bills. Represented by US bonds and Treasury bills. But in every country studied, local equities outperformed local government bonds. Treasury bills are closer to cash, with higher credit quality and shorter duration. Bonds provided much lower real returns and lower standard deviation. Bonds were heavily effected by inflation, and did worse than stocks in periods of high inflation. Bonds are the best protection against deflation.

Gold. Long-term real returns are quite low, around 1%, on par with Treasury bills but with higher standard deviation. The bright spot is that they provided the most protection against inflation.

Housing. This refers to average prices of residential real estate across many cities. Long-term real returns are about 1%. However, you get to live in your house so there is a consumption benefit. Housing is less impacted by inflation than everything except gold, but the price risk of owning a single home is probably higher than the average home price data.

When a mutual fund or hedge fund lists their historical returns, the industry standard is to use time-weighted returns that assume you buy at the beginning of the time period and hold until the end. However, what often happens is that a fund will start out small and have great returns for a while, gradually start attracting lots of investor money, and then the subsequent returns are not so hot. Whatever special inefficiency or investment idea the fund managers had initially is either wiped out by market forces over time or simply hindered by asset bloat. In such a case, the actual returns experienced by investors is less than what is listed under fund return data, even though things like 5-year trailing returns still look quite good.

Via Abnormal Returns, Ben Lorica of The Verisi Data Studio took an academic paper by Dichev and Yu [pdf] in the Journal of Financial Economics and made a nice visualization of the hunk of data presented about hedge funds:

click to enlarge

From the paper’s conclusions:

Using a comprehensive sample, the main finding is that dollar-weighted investor returns are about 3% to 7% lower than fund returns, depending on specification and time period examined. This difference is economically large, and it is enough to reverse the conclusions of existing studies which show outperformance in hedge fund returns. In addition, the estimated dollar-weighted returns are rather modest in absolute magnitude; for example, they are reliably lower than the returns of broad-based indexes like the S&P 500 and only marginally higher than risk-free rates of return.

Most of us can’t invest in hedge funds even if we wanted to, so this is best taken as a larger lesson to be careful when chasing hot returns by any money manager. You don’t want to be the last money in. Morningstar also tracks “investor returns” (dollar-weighted) separately from “total returns” (traditional, time-weighted) in their mutual fund listings.

While perusing this early retirement reading list for more books to read, I ran across an interesting fellow named Harry S. Dent, Jr. His primary theory is that age demographics are strongly correlated with the economy and thus stock market prices.

In particular, the number of households headed by 46-50 year-olds are the best indicator because they are shown to have the highest spending. This makes sense, as around age 50 is also when peak income occurs while you also have spending pressure from grown-up kids and college tuition. After that, the kids move out, things slow down, and average income drops. Here are some charts from the HS Dent Foundation website:

Source:HS Dent Foundation

By looking at birth rates and adjusting for immigration, you can basically predict how many 46-50 year-olds there will be well into the future. Here’s how the shifted birthrate data corresponds to the Dow Jones stock index adjusted for inflation:

Source:HS Dent Foundation

According to the birthrate data, we are looking at depressed prices for another 10-15 years or so, but things will pick back up after that. While I think there may be something to this concept on a long timescale, I would be careful with trying to profit with it in the short-term.

I’m actually look at Mr. Dent himself here – a quick look around shows that he is trying everything under the sun to make money from this simple theory – writing a new book every few years with mostly the same content (2011, 2009, 2006), selling $1,500 seminars to “Demographics School”, and even starting his own Dent Tactical ETF (ticker symbol: DENT) with poor performance since inception and a bloated 1.65% expense ratio. Potential investors should know that he already started a mutual fund previously that failed:

In 1999, the AIM Dent Demographics Trends Fund was launched, based on the demographic economic and lifestyle trends identified by Dent. Unfortunately, the fund’s results were miserable. From 2000 through 2004, the fund lost more than 11 percent per year and underperformed the S&P 500 Index by almost 9 percent per year. In 2005, its sponsor put investors out of their misery by merging it into the AIM Weingarten Fund.

Over the years, he has made many predictions. Some of them came true, more or less. For example, he predicted that the slowdown in Japan economy would coincide with the end of the end of their peak number of 46-50 year-olds in 1990-1994. Some of them did not, like in 2006 when he predicted the Dow Jones would reach 32,000-40,000 in the year 2010 (the highest ever close was 14,164 in 2007).

The last prediction I could find was Dow 4,000 to 6,800 somewhere around 2012. That’s over a 50% drop from today’s prices. I think I’ll add this demographics theory to my investing consciousness, but I’ll leave the bold predictions behind.