With inflation on a tear, 401(k) plans look vulnerable and BrightScope publishes a cheat sheet

In case you haven’t noticed, inflation has been creeping northward for a while now, adding an extra measure of misery to this down economy.

It’s no surprise industry leaders are divided on how rapidly prices will continue to rise. One thing is certain, however: Advisors should keep an eye on inflation-protected products.

To that end, BrightScope, a leading firm that tracks 401(k) plans, this week issued its first Top 10 Treasury Inflation Protected Securities, or TIPS, in 401(k) Plans. (See below)

“We’re putting out this data because we think it’s valuable to show the market which funds are winning and losing,” says Michael Alfred, founder of BrightScope.

Tops in TIPS

And… drum roll please… BrightScope’s top three TIPS are: PIMCO Real Return, TIAA-CREF Inflation-Linked Bond and Vanguard Inflation-Protected Securities.

But TIPS are just one popular option during steep inflation and advisors will likely be addressing others such as inflation-protected government-issued bonds as well as equities.

If the U.S inflation rate does not abate in the near future, the majority of retirement accounts could be in trouble because most don’t offer many inflation-protected products, says Alfred who estimates that fewer than 10% of 401(k) plans even offer TIPS on their menu of options for participants.

“If a plan doesn’t include [TIPS] then they need to explain why, Alfred says. “401(k) plans don’t include the alternative asset classes – and why is that?”

BrightScope’s top 10 TIPS list:

1. PIMCO Real Return

2. TIAA-CREF Inflation-Linked Bond

3. Vanguard Inflation-Protected Securities

4. SSgA Treasury Inflation-Protected Securities Index

5. BlackRock US TIPS

6. Fidelity Inflation-Protected Bond

7. American Century Inflation-Adjusted Bond

8. SSgA Government TIPS Bond Fund

9. Western Asset Inflation Indexed Plus Bond

10. American Beacon Treasury Inflation-Protected Securities

For instance, the top-ranked fund PIMCO Real Return has distribution in just 2,600 401(k) plans.

Alfred says that TIPS is an interesting category because it’s not dominated by big players such as Fidelity. He points out that many inflation protected vehicles such as commodities aren’t offered to 401(k) participants either – fewer than 2%.

Caught flat-footed

Clearly, food and gas prices have risen in the last year – always strong indicators of inflation. The Consumer Price Index has also risen steadily: In the first four months of 2011 the CPI has climbed 2.6%. On a rolling 12-month basis, inflation has risen above 3%. Additionally, interest on Treasury bills is near zero.

Inflation has been slow to rise because money has just been “sloshing around in bank accounts,” according to says Ron Surz, president and chief executive of PPCA Inc. and Target Date Solutions. But he believes that’s changing.

“I think advisors may be caught by surprise,” Surz says. “People are putting money in bonds, but they’re not putting money in inflation-protected bonds.”

Surz also warns against advisors relying on emerging-market funds as a fail-safe for beating inflation.

“People think that emerging markets will weather the storm,” he says. “It seems to me that if the U.S. gets in serious trouble that the rest of the world will feel it as well. I sure hope we come through this fine. But there’s definite cause for concern.”

Surz encourages advisors to think about adding inflation-protected government bonds such as I bonds in their portfolios.

Riding the wave

Unquestionably, there has a steady drumbeat of high-profile industry leaders cautioning about the risks of inflation and how to deal with it. On Thursday, Dreman Value Management, LLC, a value asset management company in Jersey City, released a white paper entitled: “The Case for Inflation: A Good Opportunity for Great Stock Picking.”

The paper outlines how investors should tweak their portfolios to take advantage of the upcoming economic shift.

“We’re convinced the global economy will be contending with inflation, maybe very high inflation,” says the paper’s author, E. Clifton “Cliff” Hoover Jr., Dreman’s chief investment officer in a statement. “We’re also confident that in this sort of environment there is great investment opportunity in equities, particularly for those who can pick the right stocks.”

No biggie

Still, not everyone agrees that inflation will be a major problem.

Fed chief Ben Bernanke says inflation
was a temporary state of affairs.

Federal Reserve Chairman Ben Bernanke, for one, is not panicked. At an unprecedented press conference in April he said inflation was a temporary state of affairs. And so far, the Federal Reserve doesn’t seem inclined to raise interest rates. St. Louis Fed president James Bullard was quoted recently saying the Fed won’t likely be lowering or increasing interest rates anytime soon.

Derek Jaskulski, an advisor and equity strategist with Portland Global Advisors LLC, whose firm manages $350 million in assets, doesn’t believe inflation will be a huge hurdle for investors. He points out that rising prices are usually triggered by rising wages and so far that hasn’t happened in the United States.

Jaskulski is also sanguine about the rising price of commodities like gas, seeing it as more of a cumbersome tax to consumers, not an indicator of runaway inflation. Rather than spending on non-essential goods and services, he says, consumers are holding back in order to pay for the necessities and he thinks that’s another sign that inflation won’t explode just yet.

“Right now, people are still spending less,” Jaskulski says. “They’re spending on gas and it’s become almost like a tax for them. They have no choice.”