Target-date fund managers are turning to inflation-hedging strategies to combat the impact of heightened inflation, as rising prices take a toll on the retirement portfolios of defined contribution plan participants, according to a Cerulli Edge: U.S. Asset and Wealth Management report released today.

Cerulli Associates said target-date fund managers are allocating a portion of their funds to inflation-hedging strategies such as Treasury Inflation-Protected Securities (TIPS), commodities and real assets. Most (96%) of the managers said they allocate to TIPS within at least one of their target-date series, about one-third (32%) allocate to commodities, and a smaller percentage allocate to natural resources or infrastructure funds, the report said.

Cerulli, however, pointed out that although TIPS and commodities are two of the most prevalent inflation hedging instruments, they have historically been disappointing, generating much lower returns than public equities and more mainstream fixed-income investments such as corporate bonds, non-inflation-linked treasuries, particularly during periods of relatively low, stable inflation.

“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,” Cerulli said. “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.”

The report also suggests that some retirement plan providers and fiduciaries encourage participants to consider contributing more to their retirement plan during a heightened period of inflation to offset the erosion of their purchasing power in retirement. As an example, the report said participants over age 50 who have hit their annual maximum contribution limit of $20,500 for 2022 could be allowed to contribute an additional $6,500 per year in catch-up contributions. “Some plan fiduciaries may even implement automatic escalation or raise the caps on their automatic escalation features,” Cerulli said.

But the report also acknowledged that any increase in contribution may be difficult for participants as their current living expenditures continue to rise sharply. Providers, however, can help participants make sensible adjustments to their savings behavior and retirement investing strategy by using savings tools, guidance, and advice solutions, Cerulli said. “This might include adding inflation hedging strategies to their portfolios or boosting their public equity exposure, where appropriate,” the report said.

The report also said that making informed choices around Social Security can possibly hedge inflation. It noted that individuals who delay claiming until their full retirement age of 66 or 67 “not only increase their monthly Social Security income, they may, in many cases, further insulate their retirement income from increases in inflation.”

As for younger investors, Cerulli said plan fiduciaries and providers should, in many cases, encourage them to simply “stay the course.” This is especially true since many younger investors tend to heavily invest in growth assets, such as equities, in which returns have outpaced the rate of U.S. inflation by a significant margin over long-term holding periods, Cerulli said.

Less affluent retirees, the report said, might find it more complicated to deal with inflation because they do not have the financial assets or resources to withstand a significant loss in purchasing power. Cerulli said retirees with less than $500,000 in investable assets are more concerned with outliving their money in retirement and covering healthcare expenditures.