Balancing Target-Date Risks For Changing Market Environments

Longevity risk must be balanced against other risks when managing a target-date portfolio for a diverse group of participants.

Rich Weiss, Chief Investment Officer, Multi-Asset Strategies

When constructing a target-date fund [TDF] glide path, how the fund manager addresses risk determines the success of the fund—and investors’ retirements. Building wealth fast early on is a favored approach, but American Century Investments® says it’s often forgotten—until right before a fall—that like running a marathon, winning the retirement race requires the correct pace and balance. Alison Cooke Mintzer, editor-in-chief of PLANADVISER, recently spoke with Richard Weiss, chief investment officer, multi-asset strategies, at the company about its more measured, balanced approach to managing risk and the success of that long-term strategy.

PLANADVISER: What risks should be considered in creating a glide path? Are some more significant than others?

RICH WEISS: There are a variety of risks involved in target-date fund risk management, chief among them longevity risk—the risk of outliving wealth. But constructing a superior glide path is not as simple as minimizing longevity risk, because, when you seek to do that, you exacerbate one or more of the other risks inherent in lifecycle investing. Market risk, inflation and interest rate risk, sequence-of-returns risk, tail risk, and abandonment risk all must be carefully considered, measured, and effectively balanced to design a successful target-date glide path. 

Take abandonment risk and the associated tail event risk: what are the risks of an extreme event occurring, driving down returns during a lifetime, and will that trigger a decision to abandon the strategy altogether? This is a notorious risk in retail investing because many investors without professional counseling or a professional strategy will abandon an investment at precisely the wrong time, after a big downturn. 
There are also several risks that come into and out of play during a strategy’s life cycle. Inflation and interest rate risk typically become more important in retirement as one has more fixed-income investments.

Sequence-of-returns risk is a more subtle and insidious risk concerning the steepness of the glide path. It’s basically “luck of the draw” risk, or where and when the bull and bear markets hit in a lifetime. A young investor encountering a 2008 in a very far-dated target-date fund would feel less impact in dollar terms and has the most time to make up the loss. But for investors about to retire, who have built up the majority of their retirement wealth, a significant bear market can be devastating. Consequently, the exact timing or “sequence” of returns in one’s lifetime can be a major risk.

PA: How do target-date fund managers think about and manage these risks?

WEISS: Fortunately, all the risks discussed above can be measured and managed. It’s how they are balanced, or weighted, that differentiates target-date fund managers. Individual target-date fund managers often lean toward weightings that are appropriate for only certain employee plan demographics.  

For instance, in emphasizing longevity risk, many managers aim for the highest expected return during the accumulation phase of a target-date strategy. But that brings many possible outcomes: some of the investment strategies may do very well, but others will do very poorly. Thus, there’s a dispersion of possible return outcomes and, accordingly, a larger probability of failure in retirement.

We’ve taken a more balanced approach than most of the competing target-date structures in the industry. Our position is highly differentiated because of our dedication to minimizing the subtle risks as well as the major ones. This means, at times we may not show the highest absolute return over a short period, such as in the very recent bull market. Competitors who emphasize longevity risk may have a higher return in the near term, but they also have much higher risk. How well we balance multiple risks is evident in our risk-adjusted returns over time—what’s commonly known in the industry as a Sharpe ratio. Why is risk-adjusted return an important metric to measure and compare? Because it directly relates to wealth accumulation and, in turn, successful retirement outcomes.

PA: How have you evolved your risk management approach to incorporate the market environment?

WEISS: Our goal is to fine-tune the risk-balancing act by accounting for the impact of changing market dynamics in a strategic sense, not on a tactical basis.Many providers incorporate some element of market insight into their glide paths, but we had three concerns over how this is typically done and wanted to avoid those pitfalls.

Foremost, the majority of target-date fund managers who adjust their glide paths do so on a tactical, monthly basis. But these are lifecycle strategies, meant to be held for the long term. Attempting to add a few basis points by trading in and out of the market on a short-term basis, even if possible to perform successfully, is inherently at odds with the underlying philosophy of target-date investment strategies.

Secondly, most programs are calibrated too simplistically. Many, even some of the largest in terms of AUM [assets under management], adjust their asset allocations by +/-10% anywhere along the entire glide path. That naïve symmetry doesn’t make sense from a prudent investment perspective. For example, adding 10% to a stock position for a 25-year-old is vastly different—in both risk and dollar terms—than adding 10% to equities for a 65-year-old. 

Finally, all of these programs, ours included, are probabilistic. The worst offense you can commit in target-date management is to put a retiree or near-retiree deeper into risky assets (e.g., equities) at the wrong time. That decision, if wrong, could hand the investor a significant deadweight dollar loss precisely at the wrong time in their life cycle. 

To address these concerns, our program makes a three-year assessment of the markets and the fundamental economic forces driving them, such as unemployment and GDP [gross domestic product] growth. Looking longer term and relying on fundamental data increases our confidence and accuracy.

Regarding calibration, our adjustments are asymmetric; that is, we only increase equity and risk allocation for mid-career investors and younger, and we only de-risk, or lower the equity weight, for mid-career through in-retirement investors. Our adjustments encompass age, wealth level, and risk tolerance, which we believe is a significant improvement over other target-date providers’ glide path adjustment methodologies. This prevents the potential damage from making the wrong call into equities for a retiree.

In the context of balancing risks, early on, we trade off longevity risk for market risk, and later we trade off sequence-of-returns risk for market risk. We either delay the roll-down in the glide path or accelerate it. We lean bullish for younger investors or bearish for older investors. This combination could increase the investor’s probability of a successful retirement.

PA: How do you measure the success of your approach?  

WEISS: The way we measure our success is: Have we maximized the probability of a successful retirement for the broadest number of participants? A key part of that objective is to make sure we’re reducing the possibility of bigger drawdowns, the probability of tail risk, and thereby increase risk-adjusted returns.

Our aim is to show more consistency and higher probability of successful retirements for more people over time, not just one lucky winner.

We liken target-date strategies to marathons, because target-date funds are meant to be held over years if not decades. Our goal at American Century is not to sprint and try to win the race with the fastest time, which many others in the field do, seeming to disregard the subtler risks. We want to get the most runners, the most investors, to the finish line.

You should consider the fund’s investment objectives, risks, charges and expenses carefully before you invest. The fund’s prospectus or summary prospectus, which can be obtained by visiting, contains this and other information about the fund, and should be read carefully before investing.

A target-date is the approximate year when investors plan to retire or start withdrawing their money. The investment’s principal value is not guaranteed at any time, including at the target date. Each target-date portfolio seeks the highest total return consistent with its asset mix, which is adjusted to be more conservative over time. In general, as the target year approaches, the portfolio’s allocation becomes more conservative by decreasing the allocation to stocks and increasing the allocation to bonds and money market instruments.

This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice. 

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

American Century Investment Services, Inc., Distributor  

©2017 American Century Proprietary Holdings, Inc. All rights reserved.