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The 10-page report, Retirement Inflation Threat, looked at the inflation risks for defined contribution schemes and what techniques could be used to help protect these funds.
Whereas traditional stock and bond investments typically found in most DC investment menus have delivered high enough returns to overcome purchasing power erosion across market cycles, the report said the asset classes had tended to underperform during rising inflationary climates and experienced periods of extreme downside.
Investments that have performed best during rising or high-inflationary environments are not typically offered by most DC investment line-ups. They include inflation-sensitive equities, commodities, UK linkers, direct real estate, real estate investment trusts and nominal bonds.
The report said that although none of these individual asset classes were ‘silver bullets’ alone in protecting against inflation risk, combining them in a single, well-diversified investment strategy may provide more effective protection across multiple inflationary scenarios.
DC scheme trustees should therefore consider adopting an “all-seasons” approach to protect members across all inflationary environments, it said.
The report stated: “Diversification across all of these asset classes may offer the most prudent, robust inflation protection strategy for members, helping participants safely cross the retirement finish line.
“Their broad diversification helps mitigate the individual cons of each inflation-sensitive asset class, reduces expected overall volatility and offers better protection across the entire inflation cycle. They offer participants an accessible, single entry point that easily fits into an existing allocation strategy.”
Although inflationary pressures have eased, the report pointed out that once inflation had begun to rise, the cost of adding inflation protection usually increased.
It also said scheme trustees must clearly explain to members what the strategy was designed to achieve and why they might want to include it in their allocation.
The report said: “Asset allocation education is vital. The focus should be on members five to 10 years before retirement. These investors are most susceptible to inflation risks because they don’t have the luxury of time to recoup potential losses from any inflation shocks.”
Andy Holder, director of Yorkshire-based JM Glendinning Life and Pensions, said: “Our approach is to de-risk rather than looking at specifically index linking. We tend to de-risk our clients’ portfolios into more defensive stocks, such as gilts, corporate bonds, cash and index-linked gilts, at least 10 years from retirement.
“With clients who do not want annual reviews we usually recommend lifestyle funds which have automated de-risking.”