Target-date fund managers don’t outright admit it, but they have reined in their risk-taking since the market crash of 2008, when they were barraged by furious customers, regulators, and Congress members who claimed that the labeling of 2010 funds, and maybe others, was misleading.
They may not be admitting it, but they are paying much more attention to volatility, inflation, diversification, and ensuring income after retirement.
Managers claim they haven’t actually caved in to pressure to change fund “glide paths,” – the slow shift in the ratio of equities to fixed income from the date the first dollar is invested, through the decades after the planned retirement date. Fidelity Investments’ path, for instance, still calls for about 50 percent equities at retirement, 40 percent five years later, and 20 percent fifteen years later.
But that’s only part of the story. What has changed is the makeup of the securities that comprise the equity and bond allocations. And that change is affecting the glide paths.
The most widespread innovation is more use of inflation hedges, including TIPS (Treasury inflation-protected securities), REITs (real estate investment trusts), securities tied to natural resources and other commodities, and perhaps high-yield bonds. Fund managers and consultants say this now typically constitutes around 5 percent to as much as 20 percent of the total portfolio, although that can depend on the target age.
In a similar move aimed at getting some post-retirement stability, Principal Financial Group in November 2009 created a special income-oriented fund with a heavy component of emerging markets debt, global REITs, global equities “with a dividend focus,” preferred securities, and master limited partnerships in oil and gas pipelines, according to Randy Welch, the firm’s director of investment services. The firm starts moving assets into this pool around seven to ten years before the targeted retirement year, gradually increasing the share to 6 to 8 percent of the portfolio a few years after retirement.
The other major change is a bigger allocation to international equities. Vanguard Group, for instance, in September upped its allocation to 30 percent of total equity holdings from 20 percent, at the same time that it merged the three international portfolios it had been using. Experts say that many other managers are similarly increasing their percentage, or even going up to 40 percent.
The impact on the glide path is twofold.
First, the money for these new investments has to come from somewhere. To the degree that it’s from the same overall asset class – from U.S. equities to international equities or from bonds to TIPS – the glide path’s stock-to-fixed income ratio doesn’t change. But what about REITs and commodities? “They can act more like equities, so the money can come from equities,” says Mark Kastory, an analyst at Hewitt EnnisKnupp (the investment consulting arm of Aon Hewitt). However, they aren’t equities.
Even more dramatically, David O’Meara, an investment consultant at Towers Watson, says that high-yield bonds, emerging markets debt, and commodities are often “an explicit replacement of some of the equity component, definitely de-emphasizing equities to some degree.” There’s no way that a high-yield bond or emerging markets debt can be defined as equity.
The second impact comes from the overall motivation behind all these changes -- to provide a more stabilizing force and lessen volatility. That should reduce risk and thus, perhaps, outrage after the next market slide.
“Since the financial crisis, certainly there’s been an even greater focus on trying to reduce the impact of extreme economic environments,” O’Meara says.
Fran Hawthorne is the author of the award-winning “Pension Dumping: The Reasons, the Wreckage, the Stakes for Wall Street” (Bloomberg Press) and “Inside the FDA: The Business and Politics behind the Drugs We Take and the Food We Eat” (John Wiley & Sons). She writes regularly about finance, health care, and business ethics.
