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Portfolio > Mutual Funds > Target Date Funds

TDFs Overwhelmingly Use TIPS to Hedge Inflation: Cerulli

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What You Need to Know

  • Almost all target-date fund managers used TIPS to hedge inflation, a new Cerulli report found.
  • Just over 30% used commodities as an inflation hedge.
  • For those who had alternatives allocations in TDFs, 77% utilized REITs to hedge inflation risk.

When it comes to hedging for inflation, most target date fund managers, 96% according to a recent Cerulli report, use Treasury inflation-protected securities.

However, as effective as TIPS are “at hedging against sharp, unexpected increases in inflation, they provide a relatively expensive inflation hedge and currently have negative real expected returns,” according to the report.

Only 32% of TDF fund managers use commodities to hedge inflation, 13% use natural resources, 9% infrastructure and 8% non-U.S. inflation-linked securities, the report found.

One issue with these choices, states the report, is TIPS and commodities “have historically generated much lower returns than public equities and more mainstream fixed-income investments (e.g., corporate bonds, non-inflation-linked Treasuries), particularly during periods of relatively low, stable inflation,” it states.

One example: from 2011 to 2020, the S&P Goldman Sachs Commodity Index generated a negative annual return in five out of nine years. However, in times of rising inflation, it does much better. In fact, the index returned 40.4% in 2021 and 11.6% in January 2022.

In January, David Blanchett, managing director and head of retirement research at PGIM DC Solutions, found only about 35% of plans offered a TIPS fund, with the same percentage offering real estate. In other words, he said, “while TDFs have exposure to these asset classes (and should, especially the more retirement-focused vintages), DIY participants aren’t likely to have the same opportunity.”

Blanchett added in an email to ThinkAdvisor that “TDFs are using the inflation hedging/focused strategies noted (e.g., TIPS, real estate, etc.), but the allocations tend to be relatively low. This is a situation, though, where there typically is a ‘gap’ in 401(k) menus where there are strategies commonly employed in TDFs that may not be easily/directly accessible to 401k participants because most plans don’t offer the respective strategies on the core menu.

Tipping Point

Cerulli found that market practitioners generally use the difference between the yield-to-maturity of non-inflation-linked Treasurys and TIPS of the same maturity to gauge expected inflation. However, when compared with non-inflation-linked Treasurys with the same maturity, “TIPS deliver a higher real return only if future inflation is greater than expected inflation implied by the breakeven rate,” according to the research group.

More specifically, TDF managers “like to employ higher allocations to inflation hedging strategies during the later phases of the glide path,” Cerulli states. It notes the example of Vanguard’s Target Retirement Fund, which begins allocations to TIPS five years before the retirement date.

BlackRock, it states, uses a formula to “assess the human capital of DC participants and thereby determine the appropriate point on the glide path to begin incorporating TIPS.” And T. Rowe Price uses short-term tactical allocations to TIPS.

TDF managers also use other assets to hedge inflation risk, the report states, including alternatives. Some of these are used more than others. For example, TDF managers said that within their alternative allocations, 77% currently use real estate investment trusts (REITs), while 25% use liquid alts and 21% used private or direct real estate (this is up from 13% in 2019).

Only 4% used private debt or private equity, while none used hedge funds or nontraded REITs to hedge inflation, the study found.


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