While there is a general concern that inflation may be coming, there is little consensus among target-date funds on how to prepare for it.
The managers of these funds, popular as a tool for retirement planning, adopt varying strategies for protecting investors from inflation and differ on just how much direct inflation protection is required.
"A lot of these firms are still sort of struggling with how to do it," said Josh Charlson, a senior mutual fund analyst at Morningstar Inc.
"You're seeing more and more adding some slice of TIPS," he said, referring to Treasury inflation-protected securities, a type of government bond designed to provide a return indexed to inflation.
Target-date funds are generally weighted toward stocks early in an investor's life and, as retirement moves closer, automatically shift toward more conservative investments such as bonds. That gradual shift is known as the glide path.
Some target-date series use inflation-fighting components only in their longer-dated funds, when investors are further from retirement and better able to tolerate the volatility that can result. Others employ them consistently across the glide path, Charlson said.
Long-term inflation risk is pretty low for most younger investors, so most longer-dated target-date funds address that by holding significant equity positions and diversifying globally, Charlson said.
Inflation becomes more of a concern for investors who are nearing retirement, so many short-dated funds have added a chunk of TIPS — usually not more than 10%.
"The mainstream approach is a little bit of TIPS, a little commodity exposure and some real estate," Charlson said.
Some fund families, such as Fidelity Investments, OppenheimerFunds, Principal Funds and T. Rowe Price Inc. have created diverse asset class commodities or real return funds, which permit them to use different strategies to fight inflation risk, Charlson said.
A few target-date funds have taken a more aggressive stance. Pimco RealRetirement Funds and Invesco's Balanced Risk Retirement Funds offer "balanced-risk funds," which seek to balance risk and return across a variety of asset classes, including stocks, bonds and commodities.
Rich Weiss, who oversees allocation models for American Century Investments Livestrong Funds, said TIPS are the well-established way to hedge against inflation that comes as a result of monetary policy.
The Livestrong portfolios include TIPS across their entire glide path, but have a much heavier emphasis for those nearing retirement.
TIPS make up just 3% of the 2050 portfolio, but rise to 7.4% of assets in the 2015 fund.
Some form of commodity exposure is generally used to hedge against "cost-push inflation," which results from higher production costs and is typically commodity based, Weiss said.
American Century considered adding direct commodities exposure in the past year or two, but decided against it partly because the costs of such protection had risen significantly, he said.
However, the funds' emerging markets exposure offers a fair amount of de facto commodities exposure, Weiss said.
The company will reconsider adding direct commodities exposure this year as the costs have diminished.
The Livestrong Funds also have some equity real estate investment trust exposure. REITs tend to be a good inflation protector in certain periods, but not in others, Weiss said.
Foreign currency and other types of international exposure help to hedge imported inflation, Weiss said.
