TIPS see incremental boost but still seen as wallflower

Treasury inflation-protected securities assets are making slow progress in defined contribution plan menus, but they still represent a small portion of participants' investments and asset managers' offerings.

Several surveys show relatively few DC plan participants invest in stand-alone TIPS funds. For example, in recent years, Vanguard Group Inc., Malvern, Pa., found that no more than 4% of participants in its record-kept plans chose a stand-alone TIPS fund if it was offered.

Yet among DC asset managers, TIPS reached $49.8 billion last year, reflecting an almost steady increase from the $8.72 billion in 2007, according to Pensions & Investments data. However, last year's result represented less than 1% of the total $5.84 trillion in internally managed DC assets, based on U.S. institutional tax-exempt assets.

"TIPS are not well understood by typical 401(k) participants," said David O'Meara, the New York-based director of investment services at Willis Towers Watson PLC, remarking on the low rates of investment in stand-alone TIPS funds. If plan executives are trying to streamline their menus, a stand-alone TIPS fund could be vulnerable, he added.

So where is the growth coming from?

"Target-date funds are the driving force of allocations to TIPS," said Mr. O'Meara, echoing the comments of other consultants, researchers and providers.

TIPS funds are being swept along with the tide of inflows to target-date funds, benefiting from glidepaths that contain increasing amounts of inflation protection assets for vintages that are closer to participants' retirement age.

Research by Callan LLC shows that 74% of target-date fund providers offered a TIPS component among off-the-shelf products last year, compared to 67.4% in 2013, said James Veneruso, Callan's senior vice president and defined contribution consultant based in Summit, N.J. The firm surveys providers of 64 target-date fund families, including mutual funds and collective trusts.

In another survey, Callan found the rate of participants investing in a stand-alone TIPS fund or real asset fund has never exceeded 1.91% of total plan assets for plans that offered these options in each year since 2010, he said. Real asset funds often contain a combination of TIPS, commodities and real estate investment trusts as a broader inflation hedge.

These results are part of the Callan DC Index of 100 large plans, most of which are Callan clients. During this period, the percentage of plans offering TIPS or real asset funds rose to about 37% from 15%. Most of the increase took place between 2010 and 2014.

Other annual Callan surveys in recent years show relatively little interest or action by DC executives in adding or subtracting a TIPS fund. If they removed a TIPS fund, they probably replaced it with a real assets fund, Mr. Veneruso said.

In its annual survey of client activity, Vanguard found 33% of its record-kept plans offered a stand-alone TIPS fund last year, a rate that has been consistent for several years. Last year, these plans accounted for 39% of participants.

Among participants being offered a TIPS fund, 4% invested in one, also consistent over recent years. Among all Vanguard clients, this means 1% of participants used a stand-alone TIPS fund last year.

Despite the low rate, James Martielli, Vanguard's head of defined contribution advisory services, said there's room for growth. "It could become more important as more people stay in plans rather than roll over their accounts" when they retire or leave their employer, he said.

He cited two reasons in-plan TIPS funds could be attractive for retirees who stay in their DC plans: fiduciary oversight of investment options and the possibility that in-plan fees would be lower than those for a retail fund.

Among Vanguard's DC stand-alone bond options, traditional core index funds and actively managed funds are the most offered by plans and the most used by participants. TIPS, multisector, high-yield, emerging markets, international and global funds each account for small portions of fixed-income allocations.

David Blanchett, head of retirement research, Morningstar Investment Management, Chicago, said sponsors' support of the keep-assets-in-the-plan strategies should be good news for TIPS.

"Inflation protection is a lot more important for retirees and pre-retirees," he said. "TIPS are an excellent inflation hedge. TIPS should be part of a robust core lineup."

According to Morningstar Inc. research, the number of TIPS mutual funds remained relatively flat between 2016 and late 2018, hovering around 55, after a dramatic increase since 2000. Mr. Blanchett said he expects to see more TIPS funds.

An increase in TIPS funds is desired by consultants as well, according to Pacific Investment Management Co. LLC, Newport Beach, Calif.

When asked for a preferred choice for a stand-alone inflation protection strategy, 81% of DC investment consultants cited TIPS or inflation-linked bonds, according to an annual PIMCO survey published in April. Other choices were real estate investment trusts (66%), multiasset/real asset funds (56%), direct real estate (31%) and commodities (25%). The survey contained responses from 32 consultants and advisers with 3,750 clients with more than $4 trillion in total assets.

Even though inflation has been modest, "people are concerned," said Richard Fulford, executive vice president and head of PIMCO's U.S. defined contribution business. "Consultants and advisers are saying add it as a diversifier."

Participants' adoption of investment strategies "are dependent on how well sponsors communicate," he added. When it comes to TIPS, "the communication has not been effective enough."

Given the current interest rate environment, researchers at Cerulli Associates, Boston, have noticed that target-date fund managers are dialing back on their inflation-hedging strategies, said Daniel Uquillas, senior analyst for retirement and institutional markets.

In a report due for release in September, Cerulli found 96% of target-date fund managers are allocating to TIPs in their products this year vs. 100% last year. Those allocating to commodities dropped to 52% this year from 73% last year, and those allocating non-U.S. inflation-linked securities slipped to 13% this year from 27% last year.

The strategy is "likely in part due to inflationary fears receding because of the worsening global economic outlook and higher forecasted probability of an imminent recession," the report said.

The report was based on a first quarter survey of 24 target-date fund managers representing $1.7 trillion in assets, which, Cerulli says, covers more than 95% of total target-date fund assets.