Heightened Inflation Is Eroding Plan Participants’ Retirement Savings

March 17, 2022, BOSTON—Sharp increases in inflation are eroding investors’ real returns in their retirement portfolios. To help defined contribution (DC) plan participants combat the effect of inflation, target-date managers allocate a portion of their funds to inflation-hedging strategies at opportune stages of the glidepath, according to the latest Cerulli Edge—U.S. Retirement Edition.

While DC plan participants are typically long-term, buy-and-hold investors, their investment horizons vary considerably. For older retirement investors with shorter investment horizons, inflation can be particularly troublesome because these investors generally have shorter investment horizons and more immediate liquidity requirements. Inflation is perhaps most complicated for less affluent retirees without the financial assets or resources to withstand significant losses in current and future purchasing power.

To help prepare retirement investors, many target-date managers allocate a portion of their funds to inflation-hedging strategies, including Treasury Inflation-Protected Securities (TIPS), commodities, and real assets. Nearly all target-date managers (96%) indicate they allocate to TIPS within at least one of their target-date series, approximately one-third (32%) allocate to commodities, and a smaller percentage allocate to natural resources or infrastructure funds.

While TIPS are particularly effective at hedging against sharp, unexpected increases in inflation, they provide a relatively expensive inflation hedge and currently have negative real expected returns. Compared with non-inflation-linked Treasuries with the same maturity, TIPS deliver a higher real return only if future inflation is greater than expected inflation implied by the breakeven rate. “Target-date managers are often strategic, or even tactical, when it comes to incorporating inflation-hedging strategies,” says Shawn O’Brien, associate director. “Specifically, many target-date managers like to employ higher allocations to inflation-hedging strategies during the later phases of the glidepath.”

Target-date managers also implement other asset classes that may help hedge inflation risk, including direct real estate investments, notes O’Brien. According to Cerulli, 21% of target-date managers include allocations to direct real estate within their target-date series, compared with 13% in 2019. Private real estate allocations have also become slightly more common within target-date offerings in recent years.