Inflation seems to be on everyone’s minds these days. From groceries to home prices, the recent spike in inflation touches nearly every aspect of life. According to U.S. Department of Labor data, the consumer price index climbed 7% in 2021, the largest 12-month gain since June 1982.
Inflation has remained in check for the past 40 years
As earlier generations of retirees can attest, higher inflation may, over time, erode the purchasing power of retirement savings. Sustained levels of high inflation may prevent retirement income from keeping up with price increases in goods and services.
With that in mind, you and your plan sponsor clients may want to review their plan’s investment options — especially their target date fund (TDF) — to understand how they seek to manage inflation risks for participants.
Equities have long been considered a traditional inflation hedge over the long term. Thus, the growth-oriented component of the target date glide path may be particularly important to younger participants who want to accumulate wealth and may have more time to recover from any potential market losses.
When it comes to inflation, however, not all equities are created equal. Target date managers may or may not have the flexibility to invest in underlying funds that invest in equities that are typically more resilient to inflation, such as:
In inflationary environments like this, Capital Group looks for companies with pricing power, those with the flexibility to raise their prices because of strong brands or because they provide essential services. As consumer prices continue to rise, we seek to uncover companies that can sustain pricing power as it may prove to be a competitive advantage during inflationary periods.
Retirees and those close to retirement could look to TDFs to help protect against volatility while providing income that keeps up with rising prices. This puts the emphasis on the fixed income portion of the glide path.
One increasingly popular fixed income inflation protection strategy is the use of U.S. Treasury Inflation-Protected Securities (TIPS), which adjust their income levels based on inflationary expectations. When large, unexpected pricing shocks cause inflation to exceed those expectations, TIPS can also provide capital appreciation opportunities.
As target date solutions committee member Wesley Phoa recently pointed out: “If the U.S. is indeed entering an environment of high and volatile inflation, our research suggests TIPS can provide a useful inflation hedge.”
TIPS may not be a standard inflationary hedge in core bond funds because they are not included in the Bloomberg U.S. Aggregate Bond Index benchmark. The American Funds Target Date Retirement Series® does tactically utilize underlying fixed income strategies that hold TIPS as a potential buffer against inflationary shocks.
Interest rate hikes are the typical policy response to inflation, which can stress many fixed income securities, especially higher-yielding ones. TDFs utilizing fixed income strategies that maintain a disciplined approach to the four roles of fixed income that don’t chase the yield curve in pursuit of higher income may be better positioned against inflation risks in a dynamic macroeconomic environment like the one we are in now.
At Capital Group, our TDF series is not as dependent on fixed income because of the inclusion of dividend-paying stocks. Still, inflation is a big concern, as fixed income portfolio manager Pramod Atluri explains: “We are laser focused on inflation because that’s the biggest risk to investors’ portfolios over the near term. If we are wrong about inflation, we will be wrong on the upside, so it makes sense to protect against that outcome.”
Managing inflation within a glide path can be challenging. You want to ensure there is enough equity for younger participants to build wealth and an appropriate fixed income allocation for older participants that need capital preservation.
To support this overall goal of building and preserving wealth, Capital Group takes a “glide path within a glide path” approach whereby equity and bond holdings evolve in both amount and type over time. In addition to this, we allow for a degree of asset class flexibility within both our underlying equity and bond strategies to help manage investment risks, like inflation, so the series can quickly adapt to address market conditions.
The investment community is still discussing whether this latest bout of inflation is “transient” or “sticky,” but you may not have the luxury to wait for their conclusions. Your clients need to know how their investments are positioned for inflation, and that provides an opportunity to show your value when it is most needed.
To get a better understanding of how our target date solution manages inflation risk, read our white paper.
Although the target date portfolios are managed for investors on a projected retirement date time frame, the allocation strategy does not guarantee that investors' retirement goals will be met. Investment professionals manage the portfolio, moving it from a more growth-oriented strategy to a more income-oriented focus as the target date gets closer. The target date is the year that corresponds roughly to the year in which an investor is assumed to retire and begin taking withdrawals. Investment professionals continue to manage each portfolio for approximately 30 years after it reaches its target date.
Bloomberg U.S. Aggregate Index represents the U.S. investment-grade fixed-rate bond market. This index is unmanaged, and its results include reinvested dividends and/or distributions but do not reflect the effect of sales charges, commissions, account fees, expenses or U.S. federal income taxes.
BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). Bloomberg or Bloomberg’s licensors own all proprietary rights in the Bloomberg Indices. Neither Bloomberg nor Bloomberg’s licensors approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.
Regulation & Legislation
The Capital Ideas newsletter delivers weekly investment insights straight to your inbox.
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and should not be considered advice, an endorsement or a recommendation.
All Capital Group trademarks mentioned are owned by The Capital Group Companies, Inc., an affiliated company or fund. All other company and product names mentioned are the property of their respective companies.
Use of this website is intended for U.S. residents only. Use of this website and materials is also subject to approval by your home office.
American Funds Distributors, Inc., member FINRA.
This content, developed by Capital Group, home of American Funds, should not be used as a primary basis for investment decisions and is not intended to serve as impartial investment or fiduciary advice.