3 Ways to defend against inflation in defined contribution plans

3 Ways to defend against inflation in defined contribution plans

8 minute read

May 2022

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Many DC plan professionals are reevaluating portfolio allocations amid mounting wage pressures, supply chain disruptions and commodity price shocks—conditions for which real assets are historically well suited.

KEY TAKEAWAYS

 

  • Drivers of the current business cycle, including anti-globalization forces and insufficient aggregate supply, point to enduring inflation.
  • Real assets historically have provided important allocation benefits such as inflation sensitivity, portfolio diversification and attractive risk-adjusted returns.
  • DC plan participants can achieve a level of inflation defense with allocations to real estate, infrastructure or a real assets multi-strategy solution.

Inflation likely to remain higher for longer

Inflation is surging for the first time in decades, and evidence is mounting that the spike in prices is more than temporary. A major shift in the drivers of this business cycle vs. prior expansions points to enduring inflation and a prolonged environment favorable for real assets.

In the last economic cycle, the slow and shallow recovery following the global financial crisis was characterized by deflationary globalization forces and insufficient aggregate demand (due to deleveraging in the private sector).

Consequently, core inflation in the Organization for Economic Cooperation and Development averaged just 1.8% annually between 2010 and 2020.

In contrast, this cycle has seen a rapid recovery from the Covid pandemic due to inflationary “peak globalization” forces and an over-stimulated private sector. Unprecedented consumer savings and pent-up demand are expected to support continued (albeit slowing) economic growth and business demand. At the same time, tight labor markets and impaired supply chains are driving inflationary pressures. Moreover, the longer the Russia–Ukraine war continues, the higher the likelihood that supply disruptions will endure. We believe this convergence of supply and demand pressures will result in inflation staying well above the previous-cycle average (Exhibit 1).

EXHIBIT 1
Inflation is high and broad-based
OECD consumer prices y y percent change

As today’s strong demand and impaired supply point to persistent inflation forces, investors may want to consider real assets, which often have built-in inflation escalators or may benefit directly from rising commodity prices.

The benefits of real assets in DC plans

An allocation to listed real assets provides access to a large investment universe which is distinct from global equities and offers at least three effective ways to improve potential portfolio outcomes.

Inflation sensitivity

Real assets’ economic drivers are often directly or indirectly tied to inflationary trends, historically resulting in outsized returns when inflation exceeds expectations. An allocation to real assets may help preserve future purchasing power, potentially offsetting the weak or even negative inflation sensitivity of traditional portfolios concentrated in stocks and bonds.

Diversification potential

Low correlations to traditional asset classes mean real assets may enhance portfolio diversification. That can be a valuable characteristic when the outlook for stocks and bonds is uncertain—as it is today, with stocks trading near record highs and rising interest rates weighing on fixed income investments.

Attractive risk-adjusted returns

Real assets have historically delivered attractive full-cycle returns that can potentially improve risk-adjusted portfolio returns without sacrificing growth potential. Over the last 30 years, a blend of real assets has exhibited a similar Sharpe ratio to global stocks, but with lower volatility (Exhibit 2).

EXHIBIT 2
Real assets may improve risk-adjusted performance
Annualized nominal returns and risk

3 Solutions for fighting inflation

The 60/40 stock-and-bond portfolio may not meet expectations for many DC plan participants going forward. Recent market performance and the likelihood that inflation will persist suggest that traditional, style-box-driven 401(k) options may struggle to defend against inflation—underscoring investors’ need for true diversification. We believe real assets should occupy a strategic allocation in DC plans, both for inflation sensitivity and diversification potential.

Below are three real assets funds managed by Cohen & Steers:

3 Solutions for fighting inflation

Why invest with us

Cohen & Steers is a world leader in liquid real assets and alternative income, with a global team of experienced investment professionals dedicated to understanding these complex and often inefficient markets. Founded in 1986, we have a strong track record of providing innovative diversification solutions and delivering results for our clients.

To learn more about real assets, visit cohenandsteers.com/insights.

FURTHER READING

Recession or not, growth is slowing: Our macro team’s view

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Real assets: The benefits of the blend

June 2022 | 5 mins

Investor approaches to employing real assets within their portfolio will vary. Whether looking to invest in individual asset classes or a multi-strategy blend, portfolio specialist

Inflation fighters: The case for real assets

May 2022 | 22 mins

Real assets—including real estate, infrastructure, commodities and resource equities—may offer an effective solution amid inflation risks.

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