It’s also crucial to think about liquidity and interest rate risk in a TDF’s glide path, Omar Aguilar, CIO of equities and asset allocation for Charles Schwab Investment Management (CSIM), told PLANADVISER. This was particularly important during the 2008 financial crisis when liquidity dried up quickly, he added.
CSIM has developed an approach to managing TDFs that includes a “thoughtful” glide path approach, as the company calls it. Beginning 10 years before retirement, and carrying through the decumulation phase, it’s about more than just shifting allocations from equity to fixed income – it’s time to reduce active management, protect liquidity, and factor in variables such as inflation and interest rate risk, according to Schwab. Embedded into the glide path of Schwab’s actively managed target-date strategies is an increase in short-duration bonds and cash, and strategies to offset inflation with increasing TIPS exposure and decreasing global real estate and commodities exposures.
Consider the Baby Boomers invested in TDFs who are increasing fixed-income allocations directly in advance of a rising interest rate environment. (See “Storm Clouds Gathering on Fixed Income Front.”) The approach to increasing fixed income among funds varies widely, and the risk involved in taking larger positions in bonds could have a negative impact on those in or near retirement. The bottom line is that TDFs are not created equal, so it is critical – whether you’re a plan sponsor, retail investor or adviser – to understand the approach you’re investing in, according to Schwab.
CSIM's approach to managing its TDFs also includes:
- Asset class granularity – TDFs should be diversified at the asset class level, as well as the sub-asset class level.
- Open-architecture, blended approach – In contrast to using all actively managed proprietary funds, Schwab believes a combination of active and passive strategies creates a more efficient portfolio due to the unique attributes of each investment style. In conjunction with a reduction in active management as retirement nears, this approach has produced strong results, Schwab contends.
“Our philosophy has always been about managing risk,” Aguilar said.
Aguilar cautions that simplicity is not always better when it comes to glide paths; while simplicity makes education about the glide path easier, a simple approach may lack diversification.
Providers should look at risk from different dimensions and from the perspective of employees, he concluded.