401(k) Specialist Issue 3 - 2022 - 38

401(k) INVESTMENT INSIGHT
4 Inflation-Fighting Considerations
in 401(k) Plans
By Gordon Tewell, CFA, CPC, ERPA, QKC, and Troy Jensen, APA, QKA
AS 401(K) PLAN participants near
retirement age, the risk-averse investor's
primary goal becomes capital preservation.
That can mean exchanging returns
for risk mitigation, usually by reducing the
allocation to stocks and adding to bonds.
However, a lot is happening in the bond
market, most notably inflation at a 40-year
high, pushing real yields to record low
levels. Surging inflation means a decrease
in purchasing power and the first Federal
Reserve rate hike since 2018.
In this low interest, high inflationary
environment, investors need to combat inflation's
eroding impact on portfolios while
generating income. The challenge for bond
funds is that they own bonds worth less if
newer bonds offer higher yields. That's why
bond prices are down, and their returns diminishing.
Corporates, treasury, mortgages,
long term, short term, international-you
name it, they're all red this year.
Common anti-inflation assets include
commodities, natural resources, real estate
and Treasury Inflation-Protected Securities.
Yet, these asset classes come with
challenges when implemented in defined
contribution plans, particularly for the riskaverse
bond investor looking for inflation
protection described above. Let's consider
a few.
Commodities
Commodities include grain, precious
metals, electricity, oil, beef, orange juice,
natural gas, foreign currencies and other
financial instruments. Commodities and
inflation have a unique relationship, where
commodities indicate inflation to come. As
the price of commodities rises, so does the
cost of the products commodities are used
to produce.
That relationship also carries some volatility.
Commodities depend on demand
38
ISSUE 3 2022 | 401kSpecialist.com
and supply factors, and a slight change
in supply due to geopolitical tensions or
conflicts can adversely affect prices.
Exposure to rising commodity prices
as a hedge against inflation or for capital
appreciation is a challenge for defined
contribution plan investors. Access may
come through direct investment or commodity
futures. Direct investment outside
a defined contribution plan may work well
for smaller investments in precious metals,
Gordon Tewell
" In this low
interest, high
inflationary
environment,
investors need to
combat inflation's
eroding impact
on portfolios
while generating
income. "
but it quickly becomes impractical in most
other types. A fund-based approach may
be used by a defined contribution plan using
commodity futures but can carry significant
volatility and be negatively impacted
by the cumbersome need to roll into new
futures contracts as existing contracts near
expiration.
Natural Resource Investing
Natural resource investing includes
anything mined or collected in raw form.
Natural resources may go through further
processing-say, cutting a tree into 4x4s,
2x10s, 2x4s, and so on-or packaged and
sold (a barrel of oil or a bottle of water).
Natural resources can act as stores of
value, especially during rising inflation or
currency depreciation.
Access to natural resources can be
through direct investment, as with commodities,
but this approach is impractical
for most investors, mainly defined
contribution plans. Defined contribution
plan access may come through the natural
resources equity sector, which includes
the extraction of metals, coal, metallic
ore, sand, gravel, and oil shale. It may also
include logging and drilling for oil and gas.
Unfortunately, when it comes to inflation-fighting,
natural resource funds don't
always behave the same way as natural
resources. The notion that a natural resource
company shares behave differently
from the underlying commodity may seem
puzzling. Why wouldn't the price of, say,
copper be the most significant factor in the
price movements of a copper producer?
There are fundamental differences between
these two asset classes that cause
their price levels to move independently.
Most notably, company-specific factors will
influence an organization's stock price but
not the cost of the underlying commodity.
http://www.401kSpecialist.com
401(k) Specialist Issue 3 - 2022

Table of Contents for the Digital Edition of 401(k) Specialist Issue 3 - 2022
