The wisdom of setting a predetermined glidepath for the asset allocation trajectory of a target-date fund (TDF) that can span 30 or 40 years could be questioned when there are disruptions in the market. This is why some TDF providers are dedicating modest amounts of their portfolios to tactical asset allocation.
SEI Institutional had long been applying this investment technique to its defined benefit plans, says Jake Tshudy, director of defined contribution investment strategies at SEI, in Oaks, Pennsylvania. This prompted the firm five years ago to create the Dynamic Asset Allocation Fund as one of the underlying funds in its target-date fund series, Tshudy says.
The TDFs allocate up to 10% of their assets to the Dynamic Asset Allocation Fund, but like equity exposures, this allocation declines as participants approach retirement, he says. To reduce trading fees, the fund uses an options overlay.
“Glaring economic disjoints” guide the fund’s investments, Tshudy says. For example, the fund has recently gone short on the Euro and long on the U.S. dollar. “At the same time, if we decide there is a longer-term opportunity with high yield and emerging market debt, we might make those trades in the fund if we think we are going to hold those positions for a long time,” he adds.
Nonetheless, SEI believes its TDFs’ glidepath is “the most important component” driving their investments. In addition to the inclusion of the Dynamic Asset Allocation Fund, the TDFs “do have some funds that are actively managed” but the allocation is managed “from a top-down perspective,” he says.
Likewise, the TIAA-CREF Lifecycle Fund series includes a tactical asset allocation program that it has modestly added to the series over the past two years, says John Cunniff, managing director at TIAA and manager of the funds, based in New York. “We won’t deviate more than plus-five or minus-five” to the program, he says. “This will never be more than 10% of the relative tracking error. We never want the tactical allocation to overwhelm the funds and, therefore, do not have wide limits.”
Ten years ago, there were only a handful of investment managers including tactical allocation in their TDFs, Cunniff says. Today, half of the TDFs on the market include this investment strategy.
Cunniff says the reception from retirement plan advisers and sponsors has been positive. “In meetings, when we bring up the tactical element, everyone is always interested in where the markets are today, and it leads to a fair amount of conversation about it,” he says. “The reality is, the overall strategic asset allocation [of the glidepath] will be the primary contributor” to the TDF series’ investments. “This is followed by the relative performance of the underlying portfolio managers, and then the tactical element.”
Cunniff says Morningstar data has shown that TDFs with tactical allocations slightly outperform those that do not have such allocations.
The cautious approach that SEI and TIAA take to tactical allocation inclusions in their TDFs is echoed by Prudential Retirement’s Day One Mutual Funds target-date series—but unlike other TDF managers that review their allocations on a quarterly basis, Prudential typically does this annually, says Doug McIntosh, vice president, full service investments at Prudential Retirement, in Newark, New Jersey.
“Our strategic glidepath governs our thinking, with a steep risk-off 10 years before retirement,” McIntosh says. “We typically have made small tactical moves away from the glidepath—to equities, fixed income, commodities, real estate, Treasury Protected Securites—in response to long-term capital market assumptions. We are typically in the 50 to 100 basis point range on alpha and maybe 1% on volatility. That is not to say that if we saw a major market dislocation or geopolitical event, we would not permit the funds to have the ability to move more frequently.”
That said, according to McIntosh, Prudential believes it is important to remain committed to the glidepath, so that plan advisers and sponsors can remain confident that it will remain true to the “basic philosophical assumption we have staked out that the Day One Mutual Funds will be more highly invested in equities in the early years and lower in the later years, to protect investors from behavioral risk as they approach retirement. Our careful work as an industry in trimming a little bit of emerging market here and expanding holdings in fixed income will not matter if we don’t keep people invested, so the strategic glidepath really matters.”
Additionally, McIntosh continues, commitment to a glidepath is important for both advisers and sponsors: “If there is evidence of a manager who jumps around too frequently and by too much of a degree, it will make it much harder for a consultant to tell a plan sponsor that fund will still make sense 10 years from now.”