Target date funds can’t afford to be passiveContributor Daniel Oldroyd
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 more than ten years of research on retirement plan participants’ actual saving and investing behaviors, not purely assumptions as other target date managers tend to employ. In fact, while our research looks at averages, we look beyond them as well. An effective retirement plan incorporates a multitude of choices and experiences which is why we believe in designing for the “edges” as well as the average.
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. That’s why we call it an “educated” glide path.
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 through a dynamic risk management approach.
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?
Fee efficiency and risk management are the two primary factors we use to determine which asset classes to manage actively versus passively. For certain asset classes, such as equities, we leverage passive strategies simply because they cover more efficient markets, making it easy and more cost effective to replicate the index.
We can add more value by actively managing those asset classes with the potential for greater excess returns or where passive investing is not as efficient. For example, replicating a fixed income index can be complex, costly and subject to structural biases. In fact, perfectly replicating a benchmark, such as the Bloomberg Barclays US Aggregate Bond Index, would mean having to purchase over 9,000 securities. Therefore, a well-diversified, actively-managed fixed income allocation may be able to deliver more consistent risk-adjusted returns across a range of investment environments than a more narrowly diversified, concentrated allocation confined to those fixed income indices. Active management allows us to make tactical shifts and, as a result, dampen volatility and increase the potential for generating higher returns, especially in today’s market environment.
EDUCATED GLIDE PATH BLENDING BOTH ACTIVE AND PASSIVE INVESTMENTS
Source: J.P. Morgan Asset Management. Diversification and asset allocation do not guarantee investment returns and do not eliminate the risk of loss. For illustrative purposes only.
Why is actively managing the fixed income component so important in today’s market environment?
The current 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. When interest rates change, 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.
Interest rates have finally begun to normalize. Retirement portfolios will be tested for resilience should rates continue to rise. Broadly diversified fixed income portfolios comprising a range of structures, maturities and sectors (including high yield and emerging market 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.
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 JPMorgan SmartRetirement Blend Funds.
TARGET DATE FUNDS. Target date funds are funds with the target date being the approximate date when investors plan to start withdrawing their money. 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.
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.