PIMCO’s glide path for target-date funds is the collective expression of our firm’s view on how to deliver an age-appropriate asset allocation that
best prepares defined contribution (DC) plan participants for successful retirements. As Managing Directors Mihir Worah and Ravi Mattu explain in
the following Q
&A, our glide path seeks to meet three key goals: return maximization, robust diversification and certainty of income during retirement.
Q: What are the objectives of the PIMCO glide path?
Our glide path philosophy centers on providing all participants enough income to sustain their lifestyle throughout retirement. Its unique asset allocation
is designed to optimize the goals of retirement income, return maximization and diversification of investments in an effort to generate returns no matter
the economic conditions over long investment horizons.
By designing our glide path around an income objective, our starting point differs from traditional asset allocation approaches. While customary asset
allocation starts with cash as the risk-free asset, we view cash as a risky asset. This is because the amount of income cash generates can vary widely and
depends on prevailing interest rates. Therefore, our asset allocation is more closely aligned with the goal of providing steady retirement income. Treasury
Inflation-Protected Securities (TIPS) serve as the glide path’s risk-free asset. Further, our focus on return maximization goes well beyond just U.S.
stocks: It includes meaningful positions in other high-estimated-return asset classes such as non-U.S. and emerging market (EM) equities. Our glide path
also is highly diversified, with significant allocations to real estate, EM stocks and bonds, commodities, high yield and TIPS. These are assets that can
help deliver returns to participants in a variety of growth and inflation scenarios.
Q: How often do you revisit this strategic asset allocation?
We reassess it annually following our Secular Forum. I lead a team of senior portfolio managers through a rigorous process where we revisit our priors,
incorporate our firm’s latest views and review recent industry-related data. Ravi Mattu, Joachim Fels, Jim Moore and I form the leadership team. We present
our findings to PIMCO’s Investment Committee, which must validate and approve our conclusions.
This review is critical because strategic asset allocation is the most important consideration, second only to the level of participant savings, in shaping
retirement outcomes. And while our overall strategic allocations may not change in a meaningful way on an annual basis, we are committed to ensuring that
our glide path reflects current retirement industry data along with PIMCO’s latest economic research and analytical modeling.
Q: Can you elaborate on how analytical modeling helps guide this process?
As Mihir noted, our glide path is designed around three key tenets: Risk-adjusted wealth (utility) maximization, robust diversification and a risk budget
guided by a retirement income-oriented goal. Key inputs to our modeling include PIMCO’s long-term capital market assumptions. We also incorporate the most
current retirement industry data for housing wealth, savings/contribution rates, company matching, Social Security, etc.
Two important aspects to our modeling include a participant utility function and a long-horizon return simulation engine. The utility function provides
guidance on how we allocate risk along the glide path by recognizing that participants prefer portfolios that seek to avoid retirement goal shortfalls over
striving for outcomes that overshoot their retirement goal. Our long-term simulation model provides critical insight into how much income replacement we
can expect our glide path to deliver across a full range of interest rate environments a participant could face at retirement. This is essential as the
level of interest rates will largely define the return environment a retiree faces and therefore determine the amount of expected retirement income. Our
simulation model considers thousands of plausible scenarios.
Q: How did PIMCO’s capital market assumptions change
Updates to our 2015 capital market assumptions resulted in a modest reduction of forward-looking return estimates for most asset classes with only a few
outliers, such as high yield.
While our overall expectations for long-term equity returns declined slightly, within equities, EM received the largest adjustments. To be clear, we
believe EM equities continue to have, by far, the highest return estimate among equity markets, though on the margin this advantage is less pronounced than
in our 2014 capital market assumptions. In fixed income, we’ve seen an outsize increase in the relative attractiveness of credit, especially high yield,
compared with higher-quality fixed income sectors such as intermediate core-plus and long-duration Treasuries.
Q: Did your team make any refinements to the model that affected the glide path?
One important enhancement to our modeling relates to housing wealth. Housing wealth is one of three major components affecting expected levels of income
replacement during the decumulation phase of retirement investing; in other words, we consider that most participants have built real estate wealth outside
of their DC savings through home ownership. This guided us toward lower allocations to real estate in the glide path – especially closer to retirement.
We also made a few other modest changes intended to improve the overall risk/reward characteristics of the glide path. As Ravi alluded, we decreased
exposure to real estate investment trusts (REITs) given the significant real estate allocation most participants hold via home ownership. Also, REIT
valuations are no longer quite as attractive as they were in the last few years.
While EM valuations continue to be attractive, we recalibrated the EM exposure and somewhat reduced the overall EM risk budget. These adjustments reflect
our outlook for growth and elevated EM currency volatility, and seek to limit concentrated exposures to political- and commodity-related risks associated
with EM. Most of the downward adjustments in EM allocation were directed to U.S. high yield (and to a lesser degree, U.S. equities), based on our favorable
views on the potential returns offered by high yield.
Finally, our retirement income optimization guided us toward reducing duration in the allocation furthest from retirement. This change in the optimal
portfolio was primarily related to our revised capital market assumptions, which reflect compressed duration risk premiums. In other words, the model made
a small trade-off: an improved return estimate for slightly diminished income sensitivity. We agreed with the models’ guidance as younger participants do
not need as much of this sensitivity relative to those nearing retirement when this objective is central.
Q: Can you speak to what has changed since PIMCO originally designed its glide path?
We first developed our glide path about 10 years ago
and it has evolved since then. Importantly, however, the underpinnings of this strategic asset allocation have remained a constant. We have always designed
our glide path to deliver on an income replacement goal
by focusing on maximizing
wealth and embracing
What has evolved over time is our asset allocation and analytical capabilities, along with changes in the DC marketplace. For example, features like
automatic enrollment and automatic escalation of contribution rates have helped improve how individuals participate in DC investing. Ravi, Joachim, Jim and
I strive to ensure PIMCO’s glide path remains at the leading edge of DC-related asset allocation.
Q: How can we learn more about the research and analytics used in the review process?
For those keen to dig into the details, please refer to our Quantitative Research and Analytics pieces, including “Investing in Retirement” and “Rethinking Retirement Risk.”