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Stacy Schaus, Ying Gao
Defined contribution lore suggests that participants do not worry too much about risk in target-date strategies, because these participants tend not to move their money, regardless of market volatility. What’s more, we have been told that, in order to meet their goals, participants need to accept the level of risk that’s typically embedded in target-date strategies. However, a careful look at the net flow activity into or out of target-date funds suggests that common DC lore may well be mistaken. According to the Plan Sponsor Council of America, over 76% of DC plans that automatically enroll participants into their plans use target-date strategies as the default. It’s not surprising then that, as the most prevalent default type, target-date mutual funds tracked by Morningstar as of 30 June 2012, have grown to over $440 billion, increasing from $75 billion since the Pension Protection Act of 2006 was enacted. [Note: Custom target-date strategies would add significantly to this asset value, but unfortunately cannot be tracked as readily.] Given the asset flow and the importance of the default strategy in meeting retirement income goals, we believe a close look at how participants are responding to the target-dates is critical. Our analysis of this data shows that the closer a target-date vintage comes to the stated retirement date, the more mutual fund net asset flows become correlated to market movements. This may indicate that participant risk tolerance is lower the closer one moves to retirement. Further, when we take a look at the risk of loss imbedded within the market-average glide path, we suggest that the loss potential embedded within this type of glide path exceeds the risk capacity of most workers. Our conclusion is that the market-average glide path may throw participants in over their heads, in terms of both their tolerance and their capacity for accepting risk. At PIMCO, we believe there is a better way to manage target-date assets: If we focus first on the risk capacity relative to meeting an income goal, target-date strategies may be more likely to meet the income needs of workers.
Appendix:Morningstar categoriesThe table shows the labels we use for each target-date vintage and the corresponding Morningstar universes.
It is not possible to invest directly in an unmanaged index.Starting time: January 2006 Starting age: 55 years oldStarting balance: $350,000Employee contribution rate: 12%Employer match rate: 3.5%Market-average glide path/stable value: Participants invested in market-average glide path at retirement starting at January 2006, then moved out in February 2009 and invested in stable value.Market-average glide path: Participants invested in the market-average glide path at retirement starting from January 2006 through June 2012.Returns for market-average glide path are back-tested and adjusted by inflation rate. Returns for stable value are from the Hueler Stable Value Index and are inflation-adjusted. End balance Market-average glide path: $490,864Market-average glide path/stable value: $371,262Bounce back to $350,000Market-average glide path/stable value: from February 2009 takes 17 months to bounce back in July 2010.Market-average glide path: takes three months to bounce back in May 2009.
Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. 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.The “Market Average” glide path is constructed by MarketGlide. No representation is being made that the structure of the average portfolio or any account will be the same or that similar results 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. 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.Value at Risk (VAR) estimates the risk of loss of an investment or portfolio over a given time period under normal market conditions in terms of a specific percentile threshold of loss (i.e., for a given threshold of X%, under the specific modeling assumptions used, the portfolio will incur a loss in excess of the VAR X percent of the time. Different VAR calculation methodologies may be used. VAR models can help understand what future return or loss profiles might be. However, the effectiveness of a VAR calculation is in fact constrained by its limited assumptions (for example, assumptions may involve, among other things, probability distributions, historical return modeling, factor selection, risk factor correlation, simulation methodologies). It is important that investors understand the nature of these limitations when relying upon VAR analyses. 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.This material contains the opinions of the authors but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. ©2012, PIMCO.
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, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2013, PIMCO.
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