Trends in Retirement Planning Asset Allocation - Equities Now More Attractive Than Fixed Income

Over the past 5 years retirement planning strategies used by the top asset managers in the world have experienced an increase in equity allocations and have significantly increased exposure to non-traditional asset classes. The rational conclusions are that asset managers now view equity investments as better values than fixed income investments, and that they are finding additional diversification value in non-traditional asset classes.

Investors doing their own retirement planning should compare their equity and non-traditional asset class exposure to the MarketGlide retirement planning market indexes noted in this article.

Plan Sponsors and advisors that select target date funds should re-examine target date options and determine how the asset allocation compares with the market average.

Target Date Funds = Retirement Planning Asset Allocation

The largest asset management companies in the world invest significant resources in developing and maintaining asset allocation strategies designed to help investors achieve their retirement goals. These asset allocation strategies are offered to investors through an asset manager’s target date funds. Target date funds therefore represent an asset manager’s current view of the asset allocation suitable for retirement planning at various time horizons. By tracking changes in the industry target date strategies we can follow the best of class thinking on asset allocation for retirement.

Evolution of Target Date Fund Asset Allocation Strategies 2006-2011

The Target Date segment of the mutual fund industry continues to grow rapidly. The number of fund families providing target date funds with over 2 years of returns and $100 million in AUM, have increased from just 12 in 2006, to over 37 by the end of 2010. During the past 5 years there has been a significant increase in equity exposure for the average TDF, a substantial increase in the range of risk for funds of the same target year, and additional wider array of asset classes employed in the investment strategies.

Glide Path Style Analysis (GPSA) methodology is used to construct an asset allocation glide path for each TDF manager. With the glide paths we can analyze the changes in equity exposure and the increased diversification across asset classes for each TDF fund family. The MarketGlide target date fund index aggregates and averages the individual fund manager’s glide paths. The resulting index allows for analysis of the broader industry trends.

Comparing 2006 and 2011 – Industry Average Allocation to Equities

Below is the equity exposure in the MarketGlide Index glide path at the start of 2006 compared with the equity exposure in MarketGlide index calculated at the start of 2011. Example: For the target date funds 10 years from retirement the equity exposure was 57.2% in 2006 and increased to 63.4% in 2011.

Table 1. Industry Average TDF equity allocations by years to retirement

Chart 1. Industry Average TDF equity allocations by years to retirement

The average TDF manager in 2011 not only allocates higher equity in the glide path, but also holds higher amounts of equities for longer period. The increased equity exposure is up most significantly close to retirement, but there has been some equity increase for every year in the glide path.

Comparing 2006 and 2011 – Range of Individual Manager Allocations to Equity

Over the past 5 years as the number of TDF managers included in the index have increased from 12 to 37 (at least $100 MM AUM) so has the range of glide path strategies employed.

The range of equity allocation at each point in the glide path is the difference between the equity allocation of the most aggressive TDF manager and the equity allocation of the most conservative TDF manager.

For example, referring to the chart and table below, in 2006, for the 12 fund families included in the index, the difference between the highest and lowest equities exposure with 20 years to retirement was 25%. In 2011 for the 37 TDFs, the range of equity exposure with 20 years to retirement was 36%, a significant increase of 11% in the range of equity exposure. There are now wider variations in managers’ exposure to equities across the asset management industry.

Table 2. TDF Managers Range of Equity Allocations by years to retirement

Chart 2. TDF Manager Range of Equity Allocations by years to retirement

The biggest differences are found in TDF managers’ equity allocation at the point of retirement and beyond. Referring to the Table 2 and Chart 2 above, at retirement (0 Years) the range of equity allocation has risen from 34% in 2006, to 54% in 2011, a change of 20%. That means, depending on which manager an investor picks in 2011, the resulting equity allocation could be as low as 20% equity or as high as 74% equity at time of retirement, resulting in two very dramatically different retirement outcomes and value at risk levels.

Comparing 2006 and 2011 Industry Average Glide Paths Allocation to Non-Traditional Assets

The TDF industry has also become more diversified as defined by the number of asset classes used by target date funds. The MarketGlide index analyzes the asset managers’ TDF glide paths and classifies asset classes as core or non-traditional. Core asset classes are considered to be US Large Cap Growth, US Large Cap Value, US Small Cap Growth, US Small Cap Value, International Developed Equity, US Aggregate Bonds and Cash. Non-Traditional asset classes are considered to be Emerging Markets, REITS, International Bonds, High Yield and TIPS.

For Example: At 40 years from retirement the allocation to non-traditional asset classes has increased dramatically from 1.8% to 12.8%. At the point of retirement the increased diversification has been even more significant, rising from 4.9% to 19% of the total allocation.

Table 3. Average Allocation to Non-Traditional Asset Classes

Chart 3. Average Allocation to Non-Traditional Asset Classes

Summary:

The best asset managers in the world now see better value in equities and non-traditional asset classes than they do in traditional fixed income asset classes like US Treasuries. At the same time there are wider variations in strategies and the resulting equity exposures across the asset management industry.

For retirement planning generally, investors should take note of these trends as it relates to their own portfolios. Check the MarketGlide index for your appropriate target retirement year and see if your equity exposure is higher or lower than the index. Also check non-traditional asset class exposure to see if you are well diversified.

For target date fund investors, and retirement plan sponsors and advisors that choose and monitor target date funds for retirement plans, it is critical to note the increased variation in target date strategies across the industry. If selecting a strategy that deviates significantly from the average make sure you understand the manager’s reasoning, agree with it and monitor it carefully against the MarketGlide index.