Target-date glide paths essentially operate on autopilot. But with greater volatility always popping up on the radar screen, even the best of glide paths can benefit from some tactical maneuvering.
“Set it and forget it.” That phrase has often been used to describe the ease and simplicity of a target-date solution. From a participant’s perspective, that’s pretty much true. But it shouldn’t be the case for the investment professionals managing the glide path.
We’ve previously explored how target-date funds can be enhanced by moving from a single investment manager to a multi-manager or open-architecture format and adding nontraditional asset classes to the investment mix. Those approaches can both potentially contribute to long-term results. But there’s a tactical strategy that can help moderate the short-term bumps along the road to better retirement outcomes: dynamic asset allocation.
The best target-date structures should incorporate a certain amount of flexibility; like trees and tall buildings, target-date funds need to bend with the wind. That’s because even the most thoughtful views on asset-class risk and return will need to be constantly revisited as market conditions change.
For example, there can be a significant disconnect between the volatility of a glide path that’s expected, based on the overall stock/bond mix, and the volatility that’s realized in extraordinarily volatile market environments. We’ve witnessed multiple periods of elevated risk, but it would have been particularly evident to someone who was approaching retirement in 2008, when realized volatility was double the long-run expectations (Display, left side). Volatility this high can produce a large portfolio drawdown right before a participant is about to retire and start withdrawing cash—it can permanently damage their capital and their feeling of retirement security.
Dynamic asset allocation provides the ability to monitor and adjust the glide path, thereby responding to meaningful changes in market conditions. If there’s a big increase in market volatility or a sharp change in the correlation characteristics of different diversifying asset classes, adjustments to the glide path may be able to mute the effect of those risks, providing significant benefits to participants.
We think that this type of strategy should focus primarily on risk moderation, not alpha generation. So the band (or range of flexibility) within which the overall equity allocation can be adjusted during extreme market conditions should typically be tilted toward the downside (Display, right side).
Target-date funds may be long-horizon strategies, but they’re more likely to function better if they include some capacity for flexible adjustments and aren’t simply set on autopilot. When market conditions change, the investment manager can adapt the glide path to reduce the risk to participants. The flexibility of additional volatility management is especially worthwhile just before retirement—a critical savings period for a participant’s portfolio to generate income throughout retirement.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.
“Target date” in a fund’s name refers to the approximate year when a plan participant expects to retire and begin withdrawing from his or her account. Target-date funds gradually adjust their asset allocation, lowering risk as a participant nears retirement. Investments in target-date funds are not guaranteed against loss of principal at any time, and account values can be more or less than the original amount invested—including at the time of the fund’s target date. Also, investing in target-date funds does not guarantee sufficient income in retirement.