Talking through the 2018 Guide to Retirement with a small
group of financial services trade journalists, Anne Lester, head of retirement
solutions for J.P. Morgan Asset Management, highlighted the deep analytical
work her team has done regarding the optimal shape of target-date fund (TDF)
glide paths during investors’ retirement years.
This is a subject of renewed attention among asset managers, defined
contribution (DC) plan sponsors and their advisers and consultants, Lester
said. And this is for good reason, as “waves of retiring Baby Boomers are
foregoing paychecks for plan payments—distributions from DC plan balances
accumulated during their working lives.”
Lester recounted a commonly told but important story. Until really the
last decade or so, DC plans were a nice-to-have supplement to defined benefit
(DB) pension plans. Today, for many members of the U.S. workforce, they are a
critical source of retirement income that will need to be spent down carefully
and with ongoing diligence. Additionally, Lester noted that more than 75% of DC
plans with qualified default investment alternatives (QDIAs) have chosen a TDF
as their default offering.
With all of this in mind, it is easy to see why the topic of how well
target-date funds serve investors near and in retirement is increasingly
prevalent. One of the first questions Lester advocates asking is, “What should
the glide path look like as participants move from accumulating asset balances
to spending down those balances in retirement?” And, the related question will
come up, “Should the allocation to equity risk assets continue to decline, increase
or plateau?”
The J.P. Morgan view, under Lester’s leadership, is that the allocation
to equity risk assets should gradually decline through the working years,
reaching its lowest point at or near retirement and remaining static in
retirement. Interestingly, Lester explained that her team has come to
agree with independent academic research that shows some theoretical merit to
re-risking later in retirement from a mathematical/portfolio theory
perspective. But she also talked about how behavioral constraints have to be
considered here, arguing her firm’s approach takes an appropriate middle
ground, balancing the capacity for risk in retirement with the
willingness/cognitive ability to take risk effectively.
“We take the stresses of real-life participant saving and withdrawal
behavior into account, and we rely on well-diversified glide paths to manage a
range of participant-experienced risks associated with DC investing,” Lester
explained. These include market, event, longevity, inflation and interest rate
risks.
Lester says the firm has recently focused on understanding the behaviors
of near-retirement and in-retirement clients. In doing so, the firm
incorporated a sizable dataset from Chase on household spending, including the
near-retirement years, supplementing the data on participant behavior that has
traditionally informed glide path design. In addition, the firm seeks to
“quantify and evaluate the implications of two opposing dynamics: the
willingness and the capacity to take on risk during retirement.”
“Our latest analyses further validate our thinking on glide path design,”
Lester said.
Lester pointed to recent J.P. Morgan research penned by
her asset management colleagues Daniel Oldroyd, Katherine Santiago, Marissa
Rose, and Livia Wu. As their analysis shows, as participants transition from
the accumulation to the decumulation phase, the potential adverse effects of a
market downturn on total lifetime wealth reach their peak. Simply put, as net
spending continues to deplete balances, it becomes more and more difficult to
recover from market losses, even with stronger returns in the later retirement
years.
Further impacting glide path decisions is the fact that participant cash
flows “are more volatile and varied in the near-retirement years than one might
think,” Lester warned.
“Our earlier research on participant withdrawals showed that 14% of
those over age 59 ½ withdraw, on average, 30% of their DC plan assets,” the
researchers explain. “This volatility can intensify the risks associated with a
market downturn near retirement if large spending withdrawals result in assets
being liquidated at reduced valuations.”
The latest findings using Chase data on spending validates the team’s
initial assumptions, Lester said. Spending in the near-retirement years is
volatile and varied, “to a degree that can’t be ignored when structuring glide
path allocations in this critical period.”
Another interested factor pointed out by the J.P. Morgan research team
is that “average returns in retirement matter far less than the sequence of
those returns.” As Lester summarized it, poor performance in the early (vs.
later) years can have a far more destructive impact on a portfolio’s ending
value.
Click here for the original article from Plan Sponsor.