The general idea of target-date funds is simple and highly effective: Provide an all-in-one investment option for participants who don’t have the expertise or time to allocate their own portfolios, and shift asset allocation gradually to a more conservative mix as retirement approaches. The success of TDFs has been driven by providing an investment option simple enough to overcome apathy, inattention and/or reluctance of participants to frequently manage the asset allocation of their retirement account.
However, as appealing as this formula may be for early accumulation years, the period close to and after retirement can present a challenge. Specifically, what is the appropriate asset allocation in this transitional period? Given longevity trends, most providers assume that a healthy weighting in equities makes sense, which is why, at their end dates, TDFs typically roll into portfolios with roughly 35 – 65% in equities, depending on the provider.
Unfortunately, such a heavy weighting may not make sense for all retirees: Depending on their account balances, some may not be able to put that much of their portfolios at risk; and others may have non-retirement fund assets weighted toward riskier assets and thus may want their retirement accounts skewing toward income and asset stability. In addition, as they age, some retirees may have more to lose from volatile equity exposure, as their reliance on retirement account income and shorter time horizons may diminish their opportunity to recoup market losses, should they occur. As such, near-retirees and retirees may prefer to draw from non-TDF options in plans. However, choices beyond the final target date portfolio are typically limited from a fixed income perspective, including perhaps a core or core-plus bond fund and money market account—none of which may provide the ability to shift allocations among sectors to maximize opportunities while limiting risk.
Less Equities, More Opportunity
In our view, providing a multi-sector fixed income fund within retirement plans can help address this key need. First, it dispenses with sometimes high levels of equity exposure that can run counter to the needs of income- and capital preservation-oriented investors. Second, such a fund can capitalize on the benefits of a portfolio manager actively adjusting the asset allocation of the fund—including the ability to shift allocations across bond sectors, credit levels and duration—a key feature that participants like about using target-date funds.
Even if a given retirement plan offers these bond segments as standalone strategies, it may be unrealistic to expect participants to allocate to them within portfolios and adjust their portfolios in light of market changes and individual needs—reinforcing the value of a professional manager within the multi-asset option.
A key argument in favor of TDFs and their maintenance of equity weightings is that those early in retirement may need that exposure to help offset the impacts of inflation and longevity. However, multi-asset fixed income portfolios can hold high yield, emerging markets debt and other assets that, while somewhat more volatile than traditional fixed income, can provide additional total return potential without the level of risk associated with stocks—both in terms of overall volatility and historical drawdowns (see display).
Performance and Risk
Last 20 Years Through June 30, 2023
| Total Return | Standard Deviation | Avg. Drawdown | Max Drawdown | |
|---|---|---|---|---|
| U.S. High Yield | 6.65% | 9.08 | -5.64% | -33.31% |
| Emerging Markets Debt | 5.66% | 8.94 | -6.3% | -25.85% |
| S&P 500 | 10.04% | 14.74 | -9.91% | -50.95% |
Source: Morningstar. High Yield represented by the Bloomberg High Yield Corporate Index and Emerging Markets Debt by the JPM EMBI Global Diversified Index. Returns are annualized. Data as of June 30, 2023.
All told, we believe that offering a standalone multi-sector fixed income strategy is worth considering as a way plan sponsors can add to the array of tools that near-retirement and retiree participants have at their disposal. Such an approach can not only seek to add to the potential for success in achieving individual participant goals, but also help plans retain participants in the plan post-retirement who might otherwise leave if they believe their needs are not being met.
Multi-Sector: Target Dates Without the Equity Risk
Asset Allocation Comparison
Target-Date Funds |
Multi-Sector Fixed Income |
Source: Morningstar. Target-date fund allocation is the average of the top five TDFs by assets as of June 30, 2023. The multi-sector allocation is hypothetical, based on the views of our fixed income team.