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Stacy Schaus, Ying Gao
Based on the structure of target-date strategies that are now available, it seems clear the market agrees: risk in retirement portfolios should gradually decline as the participant ages. Yet the degree to which risk should be reduced and how rapidly the allocation should shift are hotly debated. We often hear plan sponsors debating whether the target-date strategy’s asset allocation glide path should continue derisking “to” a participant’s retirement date or “through” retirement as well? At PIMCO, regardless of the terminology, what we really want to know is: What is the probability that the glide path will meet the real (i.e., inflation-adjusted) retirement income needs of plan participants? Plan sponsors not only need a glide path that helps participants reach their goals at the time of retirement, but also meets their real retirement income needs as they enter the distribution phase. Therefore, we have incorporated both “to” and “through” approaches into our target-date glide path construction, which relies on diversification in an effort to reduce risk without, we believe, sacrificing the potential for adequate returns. For example, we believe it is unnecessary to expose plan participants to the high levels of risk that appear in the “market average” target-date glide path constructed by MarketGlide, which is equally weighted across 25-30 target-date strategy managers (it includes both “to” and “through” glide paths). In fact, our view is that risk, as measured by volatility, can be cut in half as the participant approaches retirement, without sacrificing the likelihood of meeting the savings need (see detailed description of the PIMCO glide path at the end of this article).
"The term ‘glide path’ refers to the target-date strategy’s decreasing allocation of riskier assets as one approaches retirement, much like an aircraft descends as it reaches its destination. "
Past performance is not a guarantee or a reliable indicator of future results. Return assumptions are for illustrative purposes only and are not a prediction or a projection of return. Return assumption is an estimate of what investments may earn on average over the long term. Actual returns may be higher or lower than those shown and may vary substantially over shorter time periods. No fees or expenses were included in the illustration. Return assumptions have certain inherent limitations and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve. Actual returns may be higher or lower than those shown and may vary substantially over shorter time periods.The glide path is intended to illustrate how allocations among asset classes change as a target date approaches. The target asset allocation is based on a target date, which assumes a normal retirement age of 65, and time horizons based on current longevity of persons reaching retirement in average health. The glide path is designed to reduce risk as the target retirement date nears, but may also provide investors diversification across a variety of asset classes, with an emphasis on asset classes that may protect against inflation over time. The target allocations used in this presentation are for illustrative purposes only. They are based on quantitative and qualitative data relating to long-term market trends, risk metrics, correlation of asset types and actuarial assumptions of life expectancy and retirement.The PIMCO glide path implements an optimal asset allocation mix that moves from higher risk to lower risk over time and is designed to manage the risk of an individual’s savings as they approach retirement. The glide path acts as a “benchmark portfolio”, reflecting an allocation that is optimal with respect to our long-run, real return assumptions for each asset class (referred to above as “return assumptions”). The PIMCO glide path optimization takes into account the compounding of returns over the given investment horizon, unlike standard mean-variance analysis. PIMCO’s approach to developing a glide path incorporates liability-driven modeling in a “real return” framework, using a broad opportunity set of asset classes seeking to deliver meaningful improvements over traditional approaches. This approach may increase the median return and narrow the range of expected future outcomes when compared to the typical glide path (see chart in appendix), while hedging the risk of future inflation and reducing the risk of a shortfall in future sustainable spending power. More income is likely to distribute near the median.No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those shown. Hypothetical or simulated performance results have several inherent limitations. Unlike an actual performance record, simulated results do not represent actual performance and are generally prepared with the benefit of hindsight. There are frequently sharp differences between simulated performance results and the actual results subsequently achieved by any particular account, product, or strategy. In addition, since trades have not actually been executed, simulated results cannot account for the impact of certain market risks such as lack of liquidity. There are numerous other factors related to the markets in general or the implementation of any specific investment strategy, which cannot be fully accounted for in the preparation of simulated results and all of which can adversely affect actual results.Stress testing is a simulation technique used on a portfolio to determine its reactions to different hypothetical situations. PIMCO employs methodologies which may include market or other assumptions, subjective judgments and valuation models. Such assumptions, judgments and models may reflect PIMCO’s current thinking and may be changed or modified in response to PIMCO’s perception of market conditions, or otherwise.There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those shown.The portfolio analysis is based on the PIMCO glide path and market average glide path constructed by MarketGlide. No representation is being made that the structure of the average portfolio or any account will remain the same or that similar returns will be achieved. Results shown may not be attained and should not be construed as the only possibilities that exist. Different weightings in the asset allocation illustration will produce different results. Actual results will vary and are subject to change with market conditions. There is no guarantee that results will be achieved. No fees or expenses were included in the estimated results and distribution. The scenarios assume a set of assumptions that may, individually or collectively, not develop over time. The analysis reflected in this information is based upon data at time of analysis. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.PIMCO routinely reviews, modifies, and adds risk factors to its proprietary models. Due to the dynamic nature of factors affecting markets, there is no guarantee that simulations will capture all relevant risk factors or that the implementation of any resulting solutions will protect against loss. All investments contain risk and may lose value. Simulated risk analysis contains inherent limitations and is generally prepared with the benefit of hindsight. Realized losses may be larger than predicted by a given model due to additional factors that cannot be accurately forecasted or incorporated into a model based on historical or assumed data.Turbulent regime: We identify turbulent regime periods as a function of both risk factor volatility and risk factor correlation. A month is turbulent if the returns across a set of factors behave in a significantly uncharacteristic fashion. One or more factors’ returns, for example, may be unusually high or low, or two factors which are negatively correlated may move in the same direction. To calculate turbulence we measure the multivariate distance between N risk factor return observations scaled by their covariance matrix. Consider two return observations for assets and their covariance C. We compute the multivariate distance as: Where C is the covariance matrix between N risk factors, xt is a vector of N risk factor returns at time t and x is a vector of N risk factor average return. d is a multivariate distance between risk factors. To simplify, we can think of d as the difference between factors. When d is larger than some threshold (we used 15%), this signals a turbulent regime. All months in our sample for which the distance d is greater than a pre-determined threshold become part of our turbulent regime sample. We then use this turbulent regime sample to stress-test portfolios.All investments contain risk and may lose value. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk; investments may be worth more or less than the original cost when redeemed. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Inflation-linked bonds (ILBs) issued by a government are fixed-income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Treasury Inflation-Protected Securities (TIPS) are ILBs issued by the U.S. Government. Commodities contain heightened risk including market, political, regulatory, and natural conditions, and may not be suitable for all investors. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. REITs are subject to risk, such as poor performance by the manager, adverse changes to tax laws or failure to qualify for tax-free pass-through of income. Investing in securities of smaller companies tends to be more volatile and less liquid than securities of larger companies. Tail risk hedging may involve entering into financial derivatives that are expected to increase in value during the occurrence of tail events. Investing in a tail event instrument could lose all or a portion of its value even in a period of severe market stress. A tail event is unpredictable; therefore, investments in instruments tied to the occurrence of a tail event are speculative. Derivatives and commodity-linked derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Commodity-linked derivative instruments may involve additional costs and risks such as changes in commodity index volatility or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Investing in derivatives could lose more than the amount invested. This material contains the current opinions of the manager and such opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. References to specific securities are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. In addition, these references are not representation of PIMCO forecasts or expectations. The information on future results or expectations should not be construed as an estimate or promise of results that a client portfolio may achieve.
Index DescriptionsThe Barclays Capital U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis.Barclays Capital Long-Term Treasury consists of U.S. Treasury issues with maturities of 10 or more years.The Barclays Capital U.S. TIPS Index is an unmanaged market index comprised of all U.S. Treasury Inflation Protected Securities rated investment grade (Baa3 or better), have at least one year to final maturity, and at least $250 million par amount outstanding. Performance data for this index prior to 10/97 represents returns of the Lehman Inflation Notes Index.Barclays Capital U.S. Treasury Inflation Notes: 10+ Year is an unmanaged index market comprised of U.S. Treasury Inflation Protected securities with maturities of over 10 years.The BofA Merrill Lynch US 3-Month Treasury Bill Index is comprised of a single issue purchased at the beginning of the month and held for a full month. At the end of the month that issue is sold and rolled into a newly selected issue. The issue selected at each month-end rebalancing is the outstanding Treasury Bill that matures closest to, but not beyond, three months from the rebalancing date. To qualify for selection, an issue must have settled on or before the month-end rebalancing date. While the index will often hold the Treasury Bill issued at the most recent 3-month auction, it is also possible for a seasoned 6-month Bill to be selected.The Dow Jones UBS Commodity Total Return Index is an unmanaged index composed of futures contracts on 19 physical commodities. The index is designed to be a highly liquid and diversified benchmark for commodities as an asset class. Prior to May 7, 2009, this index was known as the Dow Jones AIG Commodity Total Return Index. The Dow Jones U.S. Select Real Estate Investment Trust (REIT) Total Return Index, a subset of the Dow Jones U.S. Select Real Estate Securities Total Return Index, is an unmanaged index comprised of U.S. publicly traded Real Estate Investment Trusts. This index was formerly known as the Dow Jones Wilshire REIT Index. The Morgan Stanley Capital International Emerging Markets Index is an unmanaged index that measures equity market performance in the global emerging markets. As of May 2005, the Emerging Markets Index (float-adjusted market capitalization index) consisted of indices in 26 emerging countries: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, Turkey, and Venezuela.The MSCI EAFE (Morgan Stanley Capital International Europe, Australasia, Far East Index) is an unmanaged index of over 900 companies, and is a generally accepted benchmark for major overseas markets. Index weightings represent the relative capitalizations of the major overseas markets included in the index on a U.S. dollar adjusted basis.The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index. The S&P 500 Index is an unmanaged market index generally considered representative of the stock market as a whole. The index focuses on the Large-Cap segment of the U.S. equities market. It is not possible to invest directly in an unmanaged index.
We extend our sincere appreciation to the following experts at PIMCO who kindly reviewed and added to the content of this paper:Helen GuoFinancial Engineer Client AnalyticsManny HunjanSenior Vice President, Financial Engineer Client AnalyticsSanja PetrovicSenior Developer Solutions Platform Analyst
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2015, PIMCO.
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