Some
economists believe that that recession will start to lose its grip by mid-2010,
yet on heels of that recovery, inflation will rise. Consequently, more defined-contribution
plan sponsors plan to diversify their portfolios with Treasury
Inflation-Protected Securities (TIPS).
According to California-based PIMCO, an investment management
firm, about 48% investment consultants who work with DC plan sponsors reported
that their clients are adding or considering TIPS or an annuity product to
their plans. TIPS are treasury notes in which the principal increases
with inflation and decreases with deflation.
Historically, DC plan providers have argued that their portfolios
could do without inflation-protection assets because the rate of return on
equities outpaces the rate of inflation, said Stacy Schaus, DC practice leader
at PIMCO, during a session on retirement income at the MetLife’s 5th
Annual National Benefits Symposium.
Schaus
presented findings from the firm’s 2009 survey on the DC marketplace, which
represents data from 32 consulting firms in the
While
inflation may not be a concern now, the past tells us that stocks will not
always keep pace with inflation, Schaus said. “If you look at the inflationary
period from 1962 to 1980 [primarily the 1970s], stocks were underperforming
inflation.”
The entire
survey group agreed that TIPS provided the most inflation hedge, followed by
commodities (68%) and real estate investment trusts (61%). Respondents also
said that TIPS (88%), emerging-markets equity (69%) and REITs (66%) would bring
the most value as added classes within DC plans.
Since the
inception of 401(k) plans in 1980, “we have been in a relativity high-growth
and low-inflation period, which means stocks do well-- and bonds, and perhaps
TIPS, not so well,” Schaus noted. “We are no longer in a high-growth
environment, but we are either in a low-growth environment or heading into
one.”
DC plans
mainly consist of 11 investments options that fall into five major asset
classes: non-U.S. equity, small to med cap funds, large cap funds, intermediate
bonds and stable-valve/money-market funds.
As a result,
the plans offer a low level of diversification with hedging risk against market
volatility, Schaus explained. In 2007, the investment arrangement in the
average DC account had about 70% of funds in equities and 30% in bonds.
“Asset
allocation is not the same as risk allocation. If you drill down on the 70/30
ratio, you will see that about 94% of the risk that participants face in DC
investments comes from the equity side,” Schaus noted.
Even
target-date funds, which take into account diversification, had trouble in
2008. According to Morningstar, target-date funds designed for people who will
retire in 2010 had an equity allocation of 42% and saw losses of 22% last year.
The bottom
line is that DC plans must offer “a mixture of investments to carry people
through all different types of economic scenarios,” Schaus said.
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