Sponsors mull new methods to fight inflation

Defined contribution plan sponsors have shied away from putting inflation-sensitive investments in their plan menus, but with inflation still high, some are starting to re-evaluate their thinking.

Katie Hockenmaier, Mercer's San Francisco-based U.S. defined contribution research director, for example, reports an increase in the number of plan sponsors evaluating or even adding fund options designed to soften the blow of inflation.

Multiasset real asset funds, often called diversified inflation funds, in particular, have piqued plan sponsor interest, she said.

These funds provide a mix of assets, such as Treasury inflation-protected securities, real estate investment trusts and commodities, giving participants different types of hedging mechanisms against various types of inflation, Ms. Hockenmaier said.

Over the past 18 months, more than a dozen large defined contribution plan sponsors have evaluated adding these funds to their investment lineup. Ms. Hockenmaier could not determine how many had in fact implemented the option.

While interest in stand-alone inflation-protected investments is triggering conversations, most plan sponsors remain reluctant to add them to their plans, choosing to keep their investment menus simple, even as the Federal Reserve struggles to tame inflation.

"Plan fiduciaries are balancing simplicity with diversity of choice in designing their lineups," said Mike Volo, a principal at CAPTRUST Financial Advisors LLC in Boston.

Data from Pensions & Investments' latest survey of the largest plan sponsors bears out the hesitancy toward stand-alone inflation-sensitive investments. Of the total $2.84 trillion in defined contribution assets for the 200 largest retirement plan sponsors, only $12 billion was reported in the three best-known inflation-fighting asset classes: TIPS, REITs and commodities. TIPS held $8 billion, while REITs held $3.2 billion and commodities held $800 million.

Plan sponsors don't typically offer these investments because they fear participants will not understand, or worse, misuse them. With TIPS, for instance, employees often have the perception that they're going to have a positive return regardless of the interest-rate environment, which is not the case with TIPS, said Mercer's Ms. Hockenmaier.

"In an environment like we're experiencing where TIPS have been having negative returns because of the increase in interest rates, participants may at the outset look at TIPS and think that they're going to protect against inflation and expect a positive return because inflation is positive currently," she said.

Participants also have misconceptions about REITs, thinking they're private real estate funds when they're not. "REITs generally have a high correlation with equity markets vs. a private real estate fund," Ms. Hockenmaier said.

Participants might be expecting the features of "more of a private real estate fund from a REIT fund," she added.

Mr. Volo echoed similar views, saying that plan fiduciaries may feel that the "risk profile of inflation-sensitive funds, particularly REITs and especially commodities, may not be appropriate in a stand-alone investment option."

Only about 1 in 5 of CAPTRUST's plan sponsor clients (22%) offer inflation-protected bond funds, with 17% offering REITs and 2.5% offering commodities, Mr. Volo said.

Even if inflation-sensitive investments are offered, plan sponsors find little uptake among participants. In plans that provide TIPS, for example, less than 1% of participants use them, Mr. Volo said.

Another reason plan sponsors aren't offering inflation-protected investments in their core menus is that the investments are already included in their target-date funds.

"Almost all major target-date fund providers have allocations to these asset classes," said Brian Abshire, a partner and head of DC multiasset solutions at Aon PLC in Houston. "If you took the five or 10 largest providers, they're pretty much all going to have TIPS."

Some plan sponsors also use core-plus bond funds to give retirees exposure to inflation-protected securities, Mr. Volo said.

Almost 9 in 10 of CAPTRUST's clients (87%) utilize a core-plus bond fund "where the manager allocates a portion of the portfolio to TIPS along with other alternative fixed-income investments," he said.

The question for many plan sponsors is whether to add an investment that might confuse participants when their target-date funds are already providing exposure to TIPS, REITs and other inflation-sensitive investments in a measured and appropriate way. Rather than worry about participants using the options incorrectly, plan sponsors often opt to focus on their target-date suite to make sure that it's the right one for their population, Aon's Mr. Abshire said.

That's not to say that stand-alone inflation-protected investments don't belong in plans. In some instances, they might make sense, particularly if the plan sponsor has an older workforce, according to consultants.

"The participants who probably would benefit the most are those over 60 in retirement who are taking withdrawals from their account and they're trying to maintain their spending on gas and bread," said Bill Ryan, a partner and head of defined contribution solutions at NEPC LLC in Chicago.

Retirees will need a "higher weight to inflation-sensitive assets because they're trying to hedge against the unexpected change that would compromise their spending ability," Mr. Ryan said.

Even then, though, Mr. Ryan and other consultants would be wary of adding new investments, preferring instead to allow target-date funds to do the heavy lifting in fighting inflation risk.

"I do think the primary defense against unexpected inflation or even unexpected equity rallies or shocks is through a target-date fund or some diversified portfolio because they help each of the asset classes play a certain role that counterbalance each other," Mr. Ryan said.

If plan sponsors do want to add inflation-protected securities to bolster the protection offered through their target-date funds, consultants lean toward diversified inflation funds.

"Mercer believes that tying multiple asset classes together through a multiasset diversified inflation-protection fund can actually be beneficial because having these different asset classes work together can actually provide better results vs having them on a stand-alone basis and having participants try to figure out how much to allocate to each one or whether to allocate to all of them," Ms. Hockenmaier said.

Aon, too, is a fan of diversified inflation funds.

"If you're going to offer an inflation-protected solution, you should consider a multiasset inflation-protected solution, one that's more than just TIPS but maybe has a blend of assets, such as TIPS, commodities and REITs," Mr. Abshire said.

Mr. Abshire anticipates that plan sponsors will be having more conversations around stand-alone inflation-sensitive investments and diversified funds if inflation continues to persist but wasn't sure about sponsors actually moving to add them.

"I think the dialogue is increasing. I wouldn't say the action is increasing from our perspective," he said.