PLANADVISER - September/October 2020 - 35

a sudden move from low to high inflation, which can ravage
nominal stock and bond returns, " says Bransby Whitton,
a product manager in the real asset group at investment
manager PIMCO in Newport Beach, California. " Once you're
past that, every asset in a portfolio will have been repriced
to that new level. "
" That's not to say that younger participants wouldn't
benefit from inflation-sensitive assets, although their need
is different, " Whitton observes. " It's less about inflation and
more for diversifying the returns of mainstream stocks and
bonds. In the case of target-date funds [TDFs], we take seriously
giving all participants a smoother ride. "
When inflation has been so low for so long, it is a challenge
to identify those financial assets that will deliver the
needed protection for purchasing power. The list of candidates
is sizable: TIPS [Treasury inflation-protected securities],
which adjust their principal value to increases in the
consumer price index (CPI); commodities, rising prices of
which can be the root cause of inflation; real estate, where
rents and property values tend to rise with inflation, though
over time; non-U.S. dollar currencies; and listed equities of
natural resource and infrastructure providers, whose earnings
can respond to rising prices quickly.
" Economic fundamentals tell us that a greater supply
of money chasing limited resources, from all the recent
monetary and fiscal stimulus, will push prices higher, "
says Bobby Blue, an analyst in the multi-asset team at fund
researcher Morningstar in Chicago. " But, without much
inflation in the last 30 years, it has not been a driver of
financial market returns. "
Even the longer historical record during the high-inflation
1970s and 1980s is not illuminating, he notes. " Direct
commodities in a mutual fund format were not formalized
until the 1990s, and other asset classes people point to such
as direct real estate, REITs [real estate investment trusts] and
infrastructure weren't standardized until recently, either. "
Accordingly, he concludes, " It's hard to specify a specific asset
class and know it will perform well against inflation. "
TDF Managers' Inflation Strategies
With so much to choose from, and scanty evidence, TDF
managers take varied approaches to inflation protection.
" When we construct custom TDFs, all age cohorts have
some allocation to inflation-sensitive assets. It's modest
earlier in the glide path and increases up to retirement, "
says Felicia Bennett, managing director at Wilshire Associates
in Pittsburgh. " That's consistent with many off-theshelf
TDFs, where the 2055 vintage might have 1% in TIPS,
real estate around 4.8%, and natural resource, energy and
infrastructure equities of 4.4%. Then, in income funds for
retirement, the median TIPS allocation jumps to 10%. "
Another avenue to inflation protection is a dedicated fund
in the core menu. " We tend to recommend an allocation to
a diversified public real assets fund, with a variety of asset
classes, " says Bennett. " Funds that contain some equities and
are oriented toward growth-so as to not have flat returns
when the equity market is roaring-have more volatility.
TIPS play an important role in dampening their volatility. "
Sponsor support for inflation-sensitive core options is
not universal, however. " Fund objectives are hard to explain
to participants, and some clients have declined to put
them on the table because the names can be confusing and
suggest that 'real return' means the results will always be
positive, " Bennett says. She adds, though, that they can be
useful nonetheless in a managed account setting, where the
professionally managed service could deploy an inflationsensitive
option.
For its Inflation Response Multi-Asset Fund, managers
at PIMCO prefer to invest closer to the source. " Versus the
actual commodities, public equities of natural resource
companies can offer diluted inflation protection, " notes
Whitton. " There's a positive
inflation beta from the
natural resource part, but a
negative inflation beta from
the equity component. So
natural resource equities pack
about 50% of the punch you
can get from going directly to
the commodities. "
In view of the force-feeding
of the U.S. economy from
the trillions in government
support in the COVID-19 crisis,
and potential for higher inflation,
how are TDF managers
revising their views on allocations
to inflation-sensitive
assets? At Vanguard, Senior
Product Manager Brian Miller
" What's
needed is
protection
from a
sudden
move from
low to high
inflation ... "
in Philadelphia notes that the firm does not make tactical
adjustments to its TDF glide path, and the allocation to shortterm
TIPS for older participants is steady at 17%.
According to Whitton, the inflation fighting component of
PIMCO's TDFs is currently at 16% of portfolios, down from as
high as 21% in the past five years, but, " as the risk of inflation
has increased, we could raise that allocation going forward. "
Dan Oldroyd, head of target-date strategies at J.P.
Morgan Asset Management in New York City, explains, " At
this moment, we don't have a strong view on inflation and
have not altered our positioning as a result, but we'd want
to maintain exposure to these assets in the event of any
surprises. With that said, though, we are underweighting
the real estate exposures in our glide path to reflect the
near-to-intermediate impact of COVID-19 on some sectors
of the real estate market. Therefore, the number is close to
15% at the moment. "
From his Morningstar bird's-eye view, Blue points out
that, while some managers dug in for inflation after the financial
crisis but then accommodated rising prices less when
the wave did not appear, " They're saying this time may be
different, in that money has been put directly into the hands
of consumers and that change may ultimately increase
prices. Inflation is now becoming top of mind. " -John Keefe
planadviser.com September-October 2020 | 35
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PLANADVISER - September/October 2020

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