Target-date funds (TDFs) are unlike any other class of investments. Not only do they include multiple asset classes within their overall portfolio, but they also have different risk-return trade-offs for the portfolios at various points along the glide path, or time horizon, of the investment. Throughout both bull and bear markets, they must achieve some definition of success by providing their investors with the best return possible, given the unique risks inherent in these strategies. Rich Weiss, Senior V.P. and Senior Portfolio Manager for asset allocation at American Century Investments, including the One ChoiceSM Target Date Portfolios, recently spoke with Alison Cooke Mintzer, editor-in-chief of PLANSPONSOR, about the firm’s approach to target-date fund management.
PS: As the One Choice Target Date Portfolios celebrate their 10th anniversary, what has the last decade taught you about target-date fund investing?
Weiss: At a high level, this past decade of managing target-date portfolios has shown us that helping investors build wealth for retirement is more like a marathon, not a sprint. That is, it’s not about winning the last leg or the downhill slope—which would be analogous to the bull market—it’s about outperforming over the long haul through both bull and bear markets.
Target-date fund investing strategies are designed to go the distance—spanning years if not decades. Unlike with single asset class investments, balanced funds or even target-risk funds, this element of time adds a level of complexity to portfolio management as you move through the wealth accumulation and then decumulation phases.
To continue the marathon analogy, our objective with the One Choice Portfolios is not to win with the fastest time, or give one participant the highest possible account balance, as some of our competitors have as a statistical objective. When you offer a target-date series to hundreds of thousands of participants across all different demographics, it’s about having the greatest number of them actually cross the finish line, successfully reaching fully funded retirements, even though the average balance may be lower than the winner’s. To do that, you can’t have this very rapid-pace, just-look-good-in–a-bull-market scenario. It has to be a steady, consistent pace that the most investors can tolerate. That’s our approach. We seek to provide a target-date series that has a much steadier, more consistent, lower-volatility return across time and across participants so that most of them can “win.” The fact that American Century Investments’ One Choice Portfolios just reached their 10th anniversary puts us in fairly rarified air. There are not many providers with this breadth of track record. It spans a full economic cycle, including both the 2008 debacle and then the just-as-unprecedented bull market.
PS: How are One Choice Portfolios managed to encourage participants to remain invested throughout the bull and bear markets they’ll see over their lifetimes?
Weiss: Target-date strategies present a bevy of risks not associated with other investment strategies, including longevity, abandonment and sequence-of-returns risks. It’s a balancing act: weighing all these different risks throughout a lifetime, trying not to give too much credence to one, because in weighing one more heavily, you might overexpose your investors to another.
For instance, we use sophisticated computer techniques to assess the probability of participants not outliving their money, which is the essence of longevity risk, and aim for a higher probability of a participant not running out of money.
On the one hand, getting the most return in the wealth accumulation phase seems easy—you load up on risky assets—but with that comes a much a wider dispersion, or volatility, of return and ultimately wealth outcomes. That’s why we weigh the distribution—or dispersion—of that return as heavily as the level of the ending return.
We do this because, if participants are nearing or reaching retirement and there’s a severe market shock, á la 2008, the statistics have shown that many will abandon the strategy—at precisely the wrong time. It has been shown academically, and also in the real world, that as investors accumulate wealth, they become more risk averse and generally sell or abandon their strategies when the going gets rough when it has to last throughout retirement. Participants’ peak wealth is generally at the retirement date, and that’s when abandonment risk peaks. So we also measure tail risk, the probability that an investment will experience unusually large swings in returns, and we structure the portfolios to minimize these swings.
Another major risk that is less talked about is “sequence-of-returns” risk, also known as “path dependency.” Most investors naively assume that the average return, and volatility of that return over time, is all that matters for building wealth. This is not the case. The exact sequence of returns a participant experiences matters significantly. It can alter ending wealth tenfold just because of the good luck or bad luck a participant personally experiences in the markets in his or her investing career. A bear market early on in one’s career will have significantly less impact on ending wealth than the same bear market, experienced just before your retirement date. There are different metrics to measure the degree of path dependency you have—how much potential for dispersion of returns exists over various time periods. The main method for minimizing this particular risk is to dampen the slope of the glide path. Less abrupt changes in asset allocation over time helps to immunize a portfolio from sequence-of-returns risk, at the margin.
The common denominator in all these discussions about risk in TDFs is that the risk allocation is inversely related to wealth accumulation, not just age. Many young people are very risk averse, and many are risk seeking, so simply matching risk posture or glide path to age is an antiquated concept. Wealth level determines risk tolerance and should be the major determinate of asset allocation or glide path.