Target date funds can’t afford to be passive… but can be affordable
Our blended target date funds leverage both active investments—where we can add the most value—along with passive, low-cost indexed investments.
With the retirement landscape constantly changing, the solutions of yesterday may not necessarily be the most appropriate solutions for tomorrow. Selecting the right target date series as your QDIA may well be the most important investment decision you make when it comes to your employee retirement savings plan.
Let’s start from the beginning. How was J.P. Morgan’s SmartRetirement glide path built?
The design of our glide path is informed by nearly two decades of research on retirement plan participants’ actual saving, spending and investing behaviors, an effort that cannot be matched by any other target date fund manager in the industry. In fact, we like to say that we know people better than anyone else in the industry. By carefully evaluating real-world patterns – including salary increases, contributions, loans and withdrawals – we are able to make better, more informed decisions about how the strategic asset allocation of our glide path can address actual behavior as well as the risks participants may face over their retirement investment horizons.
How do risks for participants change and how do you help?
Over the course of their working lives, retirement plan investors experience a broad range of risks that could affect their ability to reach their retirement goals. These include market risk, event risk, longevity risk, inflation risk and interest rate risk. The key is to use a balanced approach – not emphasizing one risk to the detriment of others – and manage them collectively and continuously in a thoughtful manner that puts our participants in the front and center of our investment process.
Holistically prioritizing and solving for how best to address these risks across all stages of the glide path can help temper the greatest risk of all – an investors’ ability to afford retirement.
What is a “blend” target date fund and, as an active manager, why does J.P. Morgan offer a blend series?
A blend target date fund leverages a combination of both actively managed strategies and passively managed index strategies. There are several benefits to this approach:
- Access to J.P. Morgan’s global investment platform: By leveraging our broad investment platform, we actively manage those asset classes or sectors where we can add the most value.
- Lower fees: We index asset classes or sectors where the cost effectiveness of passive management is most impactful.
With increased sensitivity to fees, we understand providers are looking for lower cost alternatives in the target date space. The JPMorgan SmartRetirement Blend Funds combine both active and passive strategies, while leveraging the same glide path, asset allocation expertise and risk management process used for our actively managed target date funds.
How do you decide which asset classes or sectors to manage actively versus passively?
A well-diversified portfolio may lead to strong risk-adjusted returns. And, in order to obtain the diversification necessary to achieve those returns, the SmartRetirement strategies invest in extended fixed income sectors – such as high yield and emerging markets debt – which typically cannot be indexed efficiently and where we can add more value through active management.
Active management of underlying strategies can help us generate more efficient risk-adjusted returns that have the potential to both mitigate volatility on the downside and lead to better income replacement outcomes. Although passive strategies offer lower-cost exposure to equity and fixed income markets, they are designed – by construction – to, at best, keep pace with market indices rather than outperform them.
That being said, there is a place for passive management, and we may choose to index some asset classes for a number of reasons, including to:
- reduce portfolio tracking error and/or volatility
- implement tactical asset allocation views in a more efficient way
- manage liquidity and cash flows
- better align with the overall objective of the portfolios, as we have done in our SmartRetirement Blend series
We have the flexibility to use passive management for fee efficiency or within asset classes where we seek the desired asset class exposure without the additional active risk. For example, in the SmartRetirement Blend series, we choose to leverage passive strategies in certain asset classes, such as U.S. equities, simply because they cover more efficient markets, making it easier and more cost effective to replicate the index.
By contrast, fixed income markets are less efficient and the indices cannot be replicated entirely, as there are over 11,600 securities in the Bloomberg Barclays US Aggregate Bond Index.* In addition, active managers with defensive characteristics can be employed at the end of the glide path to help navigate turbulent markets.
EDUCATED GLIDE PATH BLENDING BOTH ACTIVE AND PASSIVE INVESTMENTS
Why is actively managing the fixed income component so important in today’s market environment?
The current low interest rate environment is an excellent example of why it’s important to understand the level of diversification and flexibility within a target date fund’s fixed income allocation. Broadly diversified fixed income portfolios comprising a range of structures, maturities and sectors (including high yield and emerging markets debt) are likely to be in a relatively favorable position—particularly when a target date fund manager has the flexibility to shift allocations toward less interest rate sensitive areas.
When and if interest rates start to rise again, retirement portfolios will be tested for resilience. If rates rise, the price impact can vary considerably across fixed income sectors, with long-maturity, low-yielding Treasuries among the most interest rate sensitive and shorter-maturity, high yield securities among the least sensitive.
Target date funds relying solely on a core fixed income strategy may not have the breadth and flexibility to weather this kind of storm, given a lack of exposure to extended sectors that have less interest rate sensitivity. In addition, a passively managed strategy designed to replicate the US Aggregate Bond Index, for example, would not have the freedom to shift allocations among sectors within the benchmark to manage portfolio duration (the sensitivity of a portfolio’s value to changes in interest rates). In fact, over the past decade, the duration of the US Aggregate Bond Index has increased as yields have declined, making funds indexed to this benchmark even more challenged in a rising rate/declining bond price environment.
Clearly, a blend target date fund series combining the best of both worlds – leveraging the lower cost of passively managed index strategies and actively managing asset classes where the most value can be added – can serve as an attractive alternative to 100% passively indexed strategies.
Learn more about the J. P. Morgan’s target date solutions.
TARGET DATE FUNDS. Target date funds are funds with the target date being the approximate date when investors plan to retire. Generally, the asset allocation of each fund will change on an annual basis with the asset allocation becoming more conservative as the fund nears the target retirement date. The principal value of the fund(s) is not guaranteed at any time, including at the target date.
CONFLICTS OF INTEREST. Refer to the Conflicts of Interest section of the Fund's Prospectus.
RISKS ASSOCIATED WITH INVESTING IN THE FUNDS. Certain underlying J.P. Morgan Funds may invest in foreign/emerging market securities, small capitalization securities and/or high yield fixed income instruments. There may be unique risks associated with investing in these types of securities. International investing involves increased risk and volatility due to possibilities of currency exchange rate volatility, political, social or economic instability, foreign taxation and differences in auditing and other financial standards. The Fund may invest a portion of its securities in small-cap stocks. Small-capitalization funds typically carry more risk than stock funds investing in well-established "blue-chip" companies since smaller companies generally have a higher risk of failure. Historically, smaller companies' stock has experienced a greater degree of market volatility than the average stock. Securities rated below investment grade are called "high yield bonds," "non-investment-grade bonds," "below investment-grade bonds," or "junk bonds." They generally are rated in the fifth or lower rating categories of Standard & Poor's and Moody's Investor Service. Although these securities tend to provide higher yields than higher rated securities, there is a greater risk that the Fund's share price will decline. Real estate funds may be subject to a higher degree of market risk because of concentration in a specific industry, sector or geographical sector. Real estate funds may be subject to risks including, but not limited to, declines in the value of real estate, risks related to general and economic conditions, changes in the value of the underlying property owned by the trust and defaults by borrower.
There may be additional fees or expenses associated with investing in a Fund of Funds strategy.