Strategy Spotlight

Bransby Whitton Discusses the PIMCO RealRetirement Income and Distribution Strategy

The strategy is designed to grow assets and distribute inflation-adjusted income.

Growing numbers of defined contribution (DC) plan sponsors are weighing the benefits of keeping participants invested in their plans upon retirement. In some cases, more participants could mean lower fees, expanded product offerings and more robust oversight. But do sponsors have the appropriate solutions in place to support participants in the decumulation phase of their investing careers? As product manager Bransby Whitton explains in the following interview, PIMCO’s RealRetirement Income and Distribution Strategy is designed to grow assets and distribute income for individuals in retirement.

Q: What is the PIMCO RealRetirement Income and Distribution
(I&D) Strategy?
Whitton: The strategy is designed for individuals who are nearing, entering or in retirement. It aims to provide participants with a comprehensive portfolio solution that can support their income needs throughout retirement. It does this through a thoughtful strategic asset allocation coupled with PIMCO’s active management.

The strategy aims to balance the need for both capital appreciation and preservation, and recognizes that participants’ assets will be depleted during retirement. Said another way, the strategy seeks to both build and preserve purchasing power for participants looking to replace a substantial portion of their pre-retirement income. As this decumulation phase will likely last at least 20 years for most participants, the strategy needs to be able to meet this minimum requirement no matter the economic environment. For example, in determining the right mix of assets, we specifically shocked the portfolio with turbulent and inflationary market environments and optimized it for the maximum length of depletion.

Q: What makes PIMCO’s RealRetirement I&D Strategy unique?
Whitton: The strategy’s asset allocation seeks to diversify risks and balance the need for both building and preserving purchasing power. It does this by incorporating risk-appropriate allocations to asset classes with historically low correlations to traditional core bonds and U.S. stocks, such as emerging market bonds and commodities. The result is an approach, that, when compared with its peer universe, seeks to provide a lower-volatility solution with more consistent outcomes over different market environments. In addition to the advantage this strategic asset allocation may bring, PIMCO incorporates multiple active management techniques including tactical asset allocation, active management of underlying asset classes and explicit risk-mitigating strategies to seek enhanced investment returns and limit loss potential.

Q: How does the strategy seek to both preserve and build purchasing power?
Whitton: The strategy recognizes that retirees’ income-replacement needs must consider inflation as a potential challenge for maintaining one’s purchasing power. Therefore, a comprehensive portfolio solution must seek to provide an explicit defense against rising consumer prices, or inflation. PIMCO’s RealRetirement I&D Strategy takes this into account through a meaningful strategic allocation to inflation-related assets including Treasury Inflation-Protected Securities (TIPS), commodities and real estate. We believe these assets capture many of the sources that can lead to upward pressure on consumer prices and therefore should help investors’ portfolios if inflation rises.

Q: Can you elaborate on the role of active management in PIMCO’s RealRetirement I&D Strategy?
Whitton: We believe value can be created by managers with the ability to develop macroeconomic and valuation views and the skills to translate them into active positions. PIMCO has honed these capabilities over the last 40-plus years. We embrace a forward-looking asset allocation approach that seeks to optimize the portfolio’s return potential within a conservative risk budget and allows for fine-tuning to adapt to changing market conditions. PIMCO develops its views through an investment process that incorporates a longer-term view, referred to as our secular outlook, which aims to capture critical transitions in the global economy. This secular outlook is supplemented by PIMCO’s cyclical views, which look at shorter-term implications influencing the global economy. PIMCO has a time-tested track record of using active management techniques, including both top-down and bottom-up strategies, across a full range of asset classes, including fixed income, equities, inflation-related assets and alternatives. Finally, PIMCO employs an active management feature that aims to explicitly defend the RealRetirement I&D Strategy against outsize losses due to severe market environments like those experienced in 2008. These tail-risk hedges seek to benefit long-term portfolio returns by cushioning negative returns and thus providing the portfolio with liquidity that can be deployed opportunistically when liquidity is scarce.

Q: What role does risk management and tail-risk hedging play in a participant’s post-retirement portfolio?
Whitton: Risk management is one of the most important aspects of a portfolio built to provide long-lasting purchasing power during retirement. It starts with a well-diversified strategic asset allocation that is built to weather multiple economic environments. But PIMCO’s risk management goes beyond static allocations. We recognize that our first line of defense, diversification, can fail during crisis periods. For this reason, we believe it is necessary to employ tail-risk hedges as a second line of defense; as previously noted, these are intended to help protect the portfolio precisely when markets experience large and unexpected drawdowns. Our tail-risk hedges are primarily out-of-the-money options with an attachment point, or estimated maximum loss threshold, of approximately 8% to 10%. If properly implemented, this could result in a loss that would compare favorably, for example, with the experience many retirees lived through in calendar year 2008, when the Lipper Mixed Assets Target Today Index returned -15.6%. Furthermore, we believe that tail-risk hedging is not only a tool to defend against severe losses, it also can enhance long-term returns. For example, when equity risk premiums are attractive, we can increase our equity allocations to enhance long-term return potential, knowing that in the event of a sharp surprise sell-off, the tail-risk hedging portfolio may cushion losses.

Thank you, Bransby.

The Author

Bransby Whitton

Product Manager, Real Return

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Past performance is not a guarantee or a reliable indicator of future results. The Real Retirement Income and Distribution Strategy invests in other portfolios and performance is subject to underlying investment weightings which will vary. 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. Equities may decline in value due to both real and perceived general market, economic and industry conditions. 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. Sovereign securities are generally backed by the issuing government, obligations of U.S. Government agencies and authorities are supported by varying degrees but are generally not backed by the full faith of the U.S. Government; portfolios that invest in such securities are not guaranteed and will fluctuate in value. 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. 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. 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 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. Investing in derivatives could lose more than the amount invested. The cost of investing in the strategy will generally be higher than the cost of investing in a strategy that invests directly in individual stocks and bonds. Diversification does not ensure against loss.

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. Asset allocation is the process of distributing investments among various classes of investments (e.g., stocks and bonds). It does not guarantee future results, ensure a profit or protect against loss.

This material contains the opinions of the author 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. PIMCO and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Allianz Asset Management of America L.P. and Pacific Investment Management Company LLC, respectively, in the United States and throughout the world. ©2013, PIMCO.