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.

How the Market Tells Us the Appropriate Asset Allocation Strategy

Every investor should have an asset allocation strategy that is appropriate for their time horizon and investment goals.

Assuming an investor is trying to accumulate wealth to fund their retirement, an investor needs to select an asset allocation strategy, pick optimal investments for each asset class, and make changes as age or circumstances change.

There is an opportunity for investors to track an appropriate asset allocation and implement it with low cost ETFs.

If we assume that wealth to fund retirement is the goal and ask 25 mutual fund companies for an appropriate asset allocation strategy, we will get 25 different strategies.

Each mutual fund company’s asset allocation strategy are effectively presented to investors in the form of target date funds.

The asset allocation is designed to change over time to grow more conservative as the investor approaches retirement.

This is called the glide path. MarketGlide is a methodology …

Performance Update - MarketGlide, Fidelity, Vanguard and T Rowe

MarketGlide Target Date Portfolios, available as sets of low-cost ETFs at FolioInvesting.com, are performing well against target date funds from the biggest names in the industry – Fidelity, Vanguard, and T Rowe. Using data from Zephyr and IDC, we analyzed performance and volatility for MarketGlide, Fidelity, Vanguard, and T Rowe for each target date. The performance and volatility numbers are displayed in the tables below, but here are a few highlights:

• T Rowe placed #1 in YTD and one-year performance, but also was #1 in volatility for every target date.
• MarketGlide placed #2 in YTD performance behind T Rowe in 9 of 10 target dates.
• MarketGlide placed #2 in one-year performance, behind T Rowe in 8 of 10 target dates.
• MarketGlide had the lowest volatility in 4 of 10 target dates and had the 2nd lowest volatility in 3 of 10 years.
• In terms of one-year realized Sharpe Ratios (return/volatility), MarketGlide beats all three families in 9 of 10 target dates.

Choosing a Target Date Fund is Still a Risky Proposition

Target date funds all share a common goal: to give investors the appropriate asset allocation up to (or through) a specific date. Taking a look at the performance of target date funds (TDFs) during 2010 has highlighted a persistent dilemma that became apparent in 2008 – even the most conservative types can deliver a shockingly wide range of returns.

For instance, every 2010 TDF intends to give investors who are ready to retire a risk averse investment vehicle. However, in Q2 alone, between April 1st and June 30th, the most popular 2010 TDFs showed a wide range of returns, with over 7% separating the best from the worst!

Investors who are so close to retirement can not afford such a big disparity, but that’s exactly the risk they are accepting when choosing a target date fund. And for almost all investors it is a risk that is impossible to analyze and understand.

Highlights from Morningstar’s 2010 Target-Date Industry Survey

Backtesting analysis of target-date funds demonstrates that the biggest risk is selecting target-date funds that provide extreme performance surprises. Such funds generally use outlying strategies that are not easily understood. Examples include heavy equity allocations at retirement for strategies focused on “through retirement” glide paths, and investments in CDOs that were allocated as low risk short-term bond investments. This risk increases the importance of thoroughly understanding the target-date strategy and underlying investments of a selected target-date fund.

The complexity of target-date funds receives plenty of attention in the press and from regulators, but what does it mean for investors, plan sponsors and advisors? Below I highlight some interesting examples from the recent Morningstar survey of the target-date industry. The survey demonstrates that analyzing and maintaining a clear understanding of target-date fund risk is a task only a few well qualified investors should do on their own. Defaulting to a market index based approach provided by MarketGlide portfolios is the prudent choice for everyone else.

The target date fund market shows explosive growth, with over $250 billion in assets

Morningstar has noticed an explosive growth in the target date fund market. Despite some negative attention from Capitol Hill and the financial media, it is clear that investors are comfortable with using target date funds as a retirement investment vehicle. At the end of 2009, the 15 largest fund companies had over $255 billion in assets in target date funds. With such rapid growth, participants will benefit from accurate personalized projections that properly account for a target date fund glide path.

“Net assets in target-date mutual funds at the 15 largest fund companies have grown to nearly $256.5 billion at the end of 2009, according to statistics published by Morningstar.”

Read more about Morningstar’s research »
See how PlanOutcome can deliver accurate, personalized target date fund projections to participants »

How do target date funds adjust to market turmoil?

FT added some interesting perspective to the recent reports on target-date funds. Fascinating how much a TDF investment strategy can change. Principal, Fidelity and T Rowe all admitted they need to add more asset classes. It is very hard for investors and advisors to keep track and know who is making the right moves and when.

More recently Principal increased diversification by allocating to the Diversified Real Asset Fund, which invests in treasury inflation-protected securities (TIPS), commodities, real estate investment trusts (REITs), and natural resources. Weightings to some of the other underlying funds were reduced.

Mike Finnegan, chief investment officer at Principal, says: “Perhaps in retrospect we were too concentrated.” The group added another manager to the series’ core fixed income allocation in the autumn of 2008. But Mr. Finnegan says it did not change the funds’ glide paths, which determine the way asset allocation changes over the life of the funds.