In our full whitepaper, Beyond the Benchmark: Assessing Fixed Income in Target Retirement Strategies, we compared State Street’s fixed income approach to that of a prominent active target-date manager, using data going back to 2005. While we did not contest the idea that an active approach to fixed income can result in outperformance over commonly used fixed income benchmarks, we did raise question the costs, particularly to diversification, of overperformance.
Importantly, how did outperformance impact the experience of the investor in the target date fund, and how does diversification play a role in mitigating key risks?
We found that the excess return of individual active fixed income funds has typically been delivered via credit over weights, and subsequently higher correlations to equities. The fixed income allocation from the active target date manager had performed well in risk-on and growth-oriented markets, and it had modestly outperformed the State Street fixed income allocation over the time period analyzed. However, the active approach lagged significantly in negative equity markets, when participants value the diversification that fixed income is expected to provide.
While Q1 2020 presented a difficult environment for markets and the participants that rely on them for retirement savings, it also served as an opportunity to reexamine the performance of these approaches in a period of heightened market volatility. During March, as equity markets were rapidly selling off, fixed income markets were pressured due to liquidity being tested, and transaction costs were significantly elevated.
It was in this market context that we conducted our analysis by taking the five largest active target retirement strategies by assets under management and comparing the normalized monthly returns from each fixed income portfolio to the State Street fixed income allocation in both a longer-dated (far from retirement) and income fund (in retirement). We made this comparison by aggregating the performance of the fixed income components in the glidepath at these two stages.
While target date strategies differ in their objectives, generally glidepaths feature equity-heavy portfolios in the longer-dated vintages (the median glidepath holds 90% in equities for younger investors) and more balanced risk approaches in the income funds. The allocations of the income vintages vary depending on whether the glidepath is “to” or “through” retirement, but our analysis included both approaches.