By SARAH MORGAN
In the latest, but potentially risky, move to fight inflation, some of the nation's largest 401(k) providers are adding commodities funds and other alternative assets to normally play-it-safe retirement plans.
The percentage of 401(k) plans offering a commodities fund nearly doubled to just under 9% from 2007 to 2009 -- the most recent available data from Brightscope, an independent rater of 401(k) plans. During that time, assets in these funds jumped 50% to $1.5 billion. And while data for 2010 won't be available until the fall, when retirement plans are required to file their official annual disclosures to the Department of Labor, industry experts say more plans are adding the alternative investment option.
For their part, the providers say commodities funds provide much-needed diversification in a retirement portfolio -- especially during inflationary periods -- because their returns are typically not closely correlated with the broad stock market. But critics counter that commodities are notoriously flighty -- Morningstar's long-only commodity fund category is 20% more volatile than the S&P 500 index -- and may actually add risk to a portfolio. Some investment pros also question the long-term return potential of commodities, arguing that despite short-term spikes, over extended stretches of time the price of any commodity reverts to the price of production -- meaning returns will be meager.
These concerns aren't curbing interest from retirement plans. In addition to commodities funds, several 401(k) plans have introduced other inflation-fighting funds such as "real return" and "multi-asset" funds, which invest in a mix of TIPS, real estate investment trusts (REITs) and commodities, says Micah Fannin, an analyst with Mercer, a human resources consulting firm. Mercer recently surveyed 227 large retirement plan sponsors and found that 12% offer a multi-asset inflation-fighting option, and another 10% intend to add some kind of inflation protection option within the next year.
Target-date funds are also adding alternative asset classes to hedge against inflation. Of the four fund families that hold a combined 80% of all target-date assets, three have recently added commodities exposure, according to BrightScope. Fidelity's target-date funds added commodities in 2009, and T. Rowe Price and Principal added commodities in 2010. (Vanguard, the second-largest target-date provider, does not offer a commodities option; a spokeswoman says the firm aims to keep target-date funds as simple as possible because they're often used as the default option within a plan.).
The move to add commodities funds and other inflation-fighting investments comes as inflation worries mount. World food prices hit a new historic high in January, according to Oxfam International. In the U.S., the Consumer Price Index rose 3.2% in the 12 months ending in April, while the gasoline index rose 33.1%. Meanwhile, in the past few years the fund industry has created a host of new products making inflation-hedging asset classes like commodities and REITs more accessible to retail investors. "More and more, normal investment vehicles are able to replicate the returns of large [institutional] investors," says Ryan Alfred, the president of BrightScope.
Investing in commodities through a 401(k) plan may reduce some of the risk of the volatile asset since participants tend to stay put in their investments through any market swings, says Kathryn Young, a fund analyst for Morningstar. Some plans even structure their 401(k)s to prevent participants from chasing performance -- a common problem with commodities funds through "tiers," where the first tier holds the core lineup of basic stock and bond funds, and the second tier holds more alternative options like commodities; the tiers help guide participants to put most of their portfolio in the core funds, Alfred says.
The commodities funds most widely used in 401(k) plans -- the $6.6 billion T. Rowe Price New Era fund
Investors should certainly be careful not to double up on certain sectors, but investing in the commodity sector through stocks can also avoid some of the costs associated with futures contracts that can eat into returns, says Richard Fullmer, an asset allocation strategist with T. Rowe Price. The sector is volatile, but allocating some money to commodities can reduce the volatility of an overall portfolio because of their tendency to zig when other assets zag, Fullmer says. A spokeswoman for Fidelity says the Select Natural Resources fund would typically be offered as one of a group of 10 or more sector funds that plan participants can use to build a diversified portfolio, not as a stand-alone commodity option.