text: Q:
  
  Why doesn't Vanguard TIPS fund (VIPSX) match the CPI?
  
  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%.
  
  (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:
  
  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?
  
  A:
  
  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.
  
  A:
  
  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.
  
  