Rising interest rates have all eyes on fixed income, anxiously anticipating bad things to come.
Nowhere is it more prevalent in the 401k and retirement plan industry than target date funds, with many predicting turbulence for those previously smooth glide paths.
J.P. Morgan Asset Management seeks to address some of the angst in a new white paper titled, “Three questions for assessing a target date fund’s fixed income allocation.”
The paper examines the admittedly critical role of fixed income assets in target date funds, highlighting ways they can help generate strong risk-adjusted returns and manage volatility, especially now.
“The fixed income allocation can be a key differentiator among target date strategies, but its structure and management do not always get the attention they deserve within the TDF selection process,” Dan Oldroyd, Portfolio Manager and Head of Target Strategies, J.P. Morgan Asset Management, said in a statement.
Strategies obviously vary across plan sponsors based on participant needs, he added.
However, when selecting the best TDF for participants, plan sponsors should consider three things: Is the fixed income portfolio sufficiently diversified? Does the fixed income manager have the flexibility to enhance risk-adjusted returns? Can the TDF’s fixed income portfolio help weather a rise in interest rates or other changes in the economic and investment environment?
In a possible swipe at the ongoing active vs. passive play, the paper finds that “a well-diversified fixed income allocation may be able to deliver more consistent risk-adjusted returns across a range of investment environments than a more narrowly diversified, concentrated allocation confined to those fixed income indices that can be efficiently replicated.”
However, it tempers it by noting skilled active fixed income managers “generally have greater flexibility and more tools than passive managers for generating strong risk-adjusted returns over time.” Replicating a fixed income index can be more complex, costly and subject to structural bias, and involve more active decision-making, than some investors realize, it adds.
Lastly, as noted, interest rates are widely expected to climb higher. The paper instructs plan sponsors to ensure TDF strategies can adapt to such changes and represents a reasonable compromise between controlling costs and providing participants with the potential for a smooth path to a financially secure retirement.