To serve the goals of retirement investors, target date portfolios must strike an appropriate risk/reward balance over lengthy time horizons.
However, capital market trends can alter asset class relationships and open up new diversification possibilities. Thus, portfolio designs need to be reviewed periodically.
T. Rowe Price recently completed an in-depth analysis of the fixed income allocations in its target date portfolios—its series of Retirement Funds and Target Funds—with the goal of identifying potential opportunities to reduce overall portfolio risk and enhance risk-adjusted returns across the retirement glide path.
This research explored three key investment themes:
- The growth of global bond markets continues to create potentially attractive diversification opportunities for U.S. investors.
- Dynamic fixed income sector allocations can strengthen diversification by better complementing equity exposure within the overall portfolio.
- A broader fixed income opportunity set can expand the field for skilled active managers to add value.
As a result, the firm is making several changes to the fixed income allocations within T. Rowe Price’s target date strategies. These include:
- Complementing core U.S. investment-grade exposure with a non-U.S. dollar bond strategy hedged against currency fluctuations and a nontraditional global bond strategy that seeks consistent returns across the interest rate cycle.
- Adding floating rate bank loans and long-duration Treasuries as diversifying elements within the fixed income allocation, which already includes high yield and emerging markets bonds.
- Adopting a dynamic diversification approach that offsets equity volatility with long-term Treasuries in the early stages of the glide path but increases exposure to credit sectors as equity levels decline.
Historically, different fixed income sectors have tended to perform differently, due to their varied relationships to each other, to movements in interest rates, and to stock market conditions.
This means that different sectors can play varying roles within a target date strategy depending on the level of equity exposure, which gradually declines as portfolios move along their glide paths.
By varying the sector weights within the fixed income allocation, the goal is to take advantage of each sector’s distinctive performance pattern to improve diversification for the total portfolio.
Like previous modifications to the firm’s target date portfolios, the latest enhancements are the product of a rigorous research process featuring intensive portfolio modeling work. The new design reflects the best judgments of a collaborative team, which includes T. Rowe Price target date managers, multi-asset specialists, and quantitative analysts, as well as the managers of the key underlying fixed income strategies.
The changes will be phased in over an extended period beginning in the fourth quarter of 2017.
And the firm will continue to evaluate its target date portfolios with the aim of advancing the long-term retirement objectives of target date investors effectively and efficiently.
The principal value of the Retirement Funds and Target Funds (collectively, the “target date funds”) is not guaranteed at any time, including at or after the target date, which is the approximate year an investor plans to retire (assumed to be age 65) and likely stop making new investments in the fund. If an investor plans to retire significantly earlier or later than age 65, the funds may not be an appropriate investment even if the investor is retiring on or near the target date. The target date funds are not designed for a lump-sum redemption at the target date and do not guarantee a particular level of income.
Diversification cannot assure a profit or protect against loss in a declining market.