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Steve Sapra, Client Solutions & Analytics: We all are familiar with the standard risk-return tradeoff that we think about in finance. We trade off the return of an asset with its volatility.

What we’re doing in defined contribution space is really no different, except we’re trading off the level of retirement income with the uncertainty associated with retirement income.

So the same basic risk-return tradeoff, but we do it in a slightly different dimension we do in an income space.

Text on screen: RealPath Blend Glide Path

Chart: The chart shows the change in glide path portfolio allocations from 40 years to retirement to 20 years after retirement. Holdings include U.S. fixed income, global bonds, long treasuries, long TIPS, TIPS, emerging market bonds, high yield, real equities, emerging market equities, non-U.S. equities, U.S. small cap equities and U.S. large cap equities.

The net result of this is really a glide path that obviously is highly diversified and exposed to assets which we believe best mitigate the risk against negative outcomes from a retirement income perspective.

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So there’s a handful of key inputs into our process. The first one are our long-term capital market assumptions. These change very slowly over time, as you might expect, as long-term assumptions should, and largely in response to changes in valuation, and we incorporate this into our glide path review process each year, and it typically results in sort of small, incremental changes to the glide path year over year.

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Another input is the most recent data from the retirement industry, namely things like contribution rates and employer match rates. This is very important because contribution rates and match rates have changed substantially over the last 10 years, and we want to make sure that we reflect those current values when we construct our glide path.

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Another key input is social security. The role of social security in glide path construction I think is often underappreciated, and the main role that is is because social security really, in some sense, plays the role of bonds in asset allocation.

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Human nature is such that losing hurts a lot more than gaining feels good. So that means that optimizing for retirement income means that the glide path must be exposed to asset classes that we believe do the best job they can of mitigating that left tail risk in terms of retirement income,

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and we believe this is true even if comes at the expense of hitting homeruns.

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So what this means is that our glide path will generally hold more interest rate-sensitive assets, particularly as one approaches retirement.

So what does this mean in practice?

Well, first, we will substitute, to some degree, higher-yielding fixed income and long-duration fixed income for much riskier equities.

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So if your objective is to mitigate that left tail, it makes tremendous sense, we think, in our view, to use some of that risk budget that would normally go to equities to things like higher yield and fixed income and long duration, particularly at retirement.

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And secondly, as we’ve shown in our research, we believe that fixed income is an area where you’re more likely to be successful in terms of adding value over, say, something like equities.

Chart: The chart shows the change in glide path portfolio allocations from 40 years to retirement to 20 years after retirement. Holdings include U.S. fixed income, global bonds, long treasuries, long TIPS, TIPS, emerging market bonds, high yield, real equities, emerging market equities, non-U.S. equities, U.S. small cap equities and U.S. large cap equities.

And this is why our glide path is constructed to give a healthy dose of passive equities when they’re young, and then slowly gravitate toward active fixed income as they get older, where they really need the retirement-income hedging property in the glide path.

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By building a highly diversified glide path with the explicit goal of retirement income in mind, PIMCO’s objective is to get as many DC participants across the retirement income finish line as possible. Well, our glide path modeling is very sophisticated and, of course, involves extensive computations. We never lose sight of what matters the most, each and every participant.

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Disclosure

For investment professional use only; not for retail public distribution.

Past performance is not a guarantee or reliable indicator of future results.

A word about risk: All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. 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.

Glide Path is the asset allocation within a Target Date Strategy (also known as a Lifecycle or Target Maturity strategy) that adjusts over time as the participant’s age increases and their time horizon to retirement shortens. The basis of the Glide Path is to reduce the portfolio risk as the participant’s time horizon decreases. Typically, younger participants with a longer time horizon to retirement have sufficient time to recover from market losses, their investment risk level is higher, and they are able to make larger contributions (depending on various factors such as salary, savings, account balance, etc.). Generally, older participants and eligible retirees have shorter time horizons to retirement and their investment risk level declines as preserving income wealth becomes more important.

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.

References to specific securities and their issuers are not intended and should not be interpreted as recommendations to purchase, sell or hold such securities. PIMCO products and strategies may or may not include the securities referenced and, if such securities are included, no representation is being made that such securities will continue to be included.

This material contains the opinions of the manager 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. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2019 PIMCO.

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