Target Date Evolution: Active Asset Allocation Aims to Improve Retirement Outcomes

Transcription

1 Target Date Evolution: Active Asset Allocation Aims to Improve Retirement Outcomes August 2014 Since the launch of the Fidelity Freedom Funds in 1996, which helped pioneer the concept of target date investing, Fidelity has made regular enhancements to its strategies in an effort to help improve retirement outcomes for shareholders. Most recently, these enhancements included changes to the glide path (i.e., time-varying strategic asset allocation) based on a refined assessment of the risk capacity of investors across the age spectrum, the integration of updated retirement plan participant behavior and demographics, and our revised long-term expectations for capital markets. Additionally, Fidelity introduced new underlying investment strategies Series funds that are dedicated for use in asset allocation strategies such as the Fidelity Freedom Funds and Fidelity Advisor Freedom Funds. Our latest enhancement is the addition of active asset allocation, a capability that allows our portfolio managers to make incremental adjustments to the target date portfolios allocations relative to the strategic glide path. Active management has been a hallmark at Fidelity. We believe including this capability in the investment process for Fidelity s target date strategies can improve risk-adjusted performance and help investors achieve their retirement income goals. The goal and construction of Fidelity s glide path Since their inception, the goal of Fidelity s target date portfolios has remained consistent: to build a portfolio to help investors achieve retirement readiness 1 by adjusting the strategic asset allocation EXHIBIT 1: Active asset allocation for Fidelity s target date strategies refers to an incremental change in the portfolio s allocation relative to the glide path (time-varying strategic asset allocation) based primarily on intermediate-term (one to five year) research views. Allocation 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% ACTIVE ASSET ALLOCATION & FIDELITY GLIDE PATH Portfolio adjustments relative to strategic glide path Objective: Improve Outcomes Strategic Glide Path Active Asset Allocation Range (+/ 10 percentage points)* Years to Retirement Glide path as of July 28, Future strategic asset allocations may differ from this illustration.*in the early savings/accumulation years, we would not expect the active asset allocation range for equities to exceed 95%. Source: Fidelity Investments. Brett Sumsion, CFA Andrew Dierdorf, CFA Mathew Jensen, CFA Director, Target Date Strategies KEY TAKEAWAYS Fidelity has added active asset allocation to its target date strategies, an approach that allows portfolio managers to adjust the strategic asset allocation to major asset classes to be different from the glide path (range of +/- 10 percentage points). This investment approach was added in an effort to help improve risk-adjusted returns for our target date portfolios, and to help increase the likelihood of investors achieving a retirement income-replacement goal of about 50% of final salary. While the glide path is informed by multiple factors, including our long-term return expectations for major asset classes, active allocation decisions focus on enhancing performance when asset prices vary from our long-term expectations over an intermediate-term horizon. Active asset allocation leverages existing research and portfolio management capabilities within Fidelity s investment organization, where this approach has been applied for many years. Active asset allocation is implemented in a risk-controlled manner, focusing on improving investor returns while maintaining the integrity of the strategic glide path.

2 over time. The glide path for Fidelity s target date strategies focuses on accumulating assets for shareholders. Considering certain assumptions, the glide path seeks to provide inflationadjusted retirement income equal to approximately half the final preretirement salary of an investor. 2 Achieving this goal requires a combination of prudent investor contributions and withdrawals, and appropriate portfolio returns. Fidelity s glide path is designed with a long-term orientation, balancing expected return and expected risk in an investor s time horizon. The strategic asset mix at each age is informed by multiple factors, including Fidelity s expectations for the return, risk, and correlations of capital markets over a 20-year forecast period. 3 Further, this strategic asset mix seeks to provide portfolio returns that are sufficient to achieve the glide path s income-replacement goal, while maintaining a level of risk that is consistent with the age, time horizon, and risk tolerance of a broad population of investors. 4 Active asset allocation: A complementary approach supported by extensive research capabilities While the glide path is based on multiple long-term factors, the prices of financial assets can move significantly over shorter-term horizons. These market dynamics can occur for many reasons, including shifting macroeconomic conditions and business cycles, changing corporate fundamentals, geopolitical events, and investor sentiment. Importantly, such asset-class pricing deviations can present opportunities to improve a target date portfolio s performance by making incremental adjustments to its allocation relative to the strategic glide path. We refer to this adjustment to a portfolio s positioning as active asset allocation. The active asset allocation investment process for our target date strategies is a research-driven approach focused on identifying mispriced asset classes. Leveraging our research capabilities, we analyze and evaluate the investment potential of asset classes over multiple time horizons. When considering this research in the context of the target date strategies, we believe that active allocation opportunities focused primarily on an intermediate-term horizon (one to five years) can help improve risk-adjusted returns for our target date portfolios over time. At the same time, because the performance of major asset classes periodically can change Shifts in the pricing of major asset classes can present opportunities to improve a target date portfolio s performance by making incremental adjustments to its allocation in relation to the strategic glide path. EXHIBIT 2: Fidelity s Asset Allocation Research Team (AART) produces research that evaluates the relative attractiveness among various asset classes during each phase of the business cycle. Fixed Income AART Business Cycle Views on Major Asset Classes Short-Term (Cash) Strong positive Strong negative Source: Fidelity Investments. Early Mid Late Recession Weak positive Weak negative Neutral more rapidly than expected, we also maintain the flexibility to make active allocation decisions over multiple time horizons. Our target date portfolio managers draw upon the following research capabilities across Fidelity s investment organization, capabilities that we believe are unmatched in the industry and differentiate our ability to improve risk-adjusted returns through active asset allocation: Asset Allocation Research Team (AART). Using an econometric framework, Fidelity s AART evaluates the business cycle across the world s major economies, based on an understanding of the aggregate inventory, profit, and credit cycles unique to each market. Because assets often perform differently during the various business cycle phases, AART s cyclical research can provide insight into periods when expected asset class returns deviate from the long-term assumptions. For example, while the long-term expectation for equity market returns may be positive, the expected performance for equities during the recessionary phase of the business cycle will likely be negative. By adjusting the positioning of the portfolio to reflect this type of research, the results for the target date strategies may be improved (see Exhibit 2, above). Fundamental research from Fidelity portfolio managers and analysts. As part of the investment process for the target date strategies, the portfolio management team meets regularly with the portfolio managers and analysts for Fidelity s equity and fixed-income strategies. These meetings provide an opportunity to share fundamental research and insights related to the investment dynamics for individual companies and markets. This fundamental research is helpful in understanding the relationships of asset classes at a granular level, and informs the investment process and active allocation decisions for the target date strategies. Asset allocation committees. Within Fidelity, there are multiple cross-organizational asset allocation committees that include investment professionals from each of the major asset classes. These committees focus on discussion, evaluation, and investment opportunities across U.S. and global investment 2

3 markets. The dialogue and recommendations from the committees serve as another source of information behind the active allocation process for the target date strategies. Quantitative models. Within the investment process for the target date strategies, a variety of quantitative frameworks are utilized to evaluate markets, asset classes, and the risk profile of portfolios. For example, quantitative research that highlights the relationships among asset classes across time can provide signals for potential mispricing that may occur. Additionally, multi-asset-class risk models aggregate the underlying holdings in the portfolios, and help the portfolio management team to evaluate position sizing and the resulting risk exposures in the target date strategies. Each of these research resources helps the portfolio management team of our target date strategies form views on the relative value among asset classes. Our active allocation decisions are based on the conviction we have in identifying mispriced assets, while considering macroeconomic conditions, fundamentals, valuation, and sentiment analysis. In addition, there may be times when our research indicates there are no compelling opportunities that warrant an adjustment to the portfolio s strategic allocations. In EXHIBIT 3: The investment universe of asset classes for Fidelity s target date strategies draws upon multiple research capabilities from across Fidelity s investment management organization. INVESTMENT UNIVERSE FOR FIDELITY TARGET DATE PORTFOLIOS Short-Term Commodities U.S. Inflation- Protected Investment Grade Non-U.S. Developed-Market Active Asset Allocation Real Estate Fixed Income Emerging Market Emerging Market Floating Rate High Yield Source: Fidelity Investments, as of July 28, For illustrative purposes only. The active asset allocation investment process for our target date strategies is a research-driven approach focused on identifying mispriced asset classes, primarily over an intermediate-term horizon. these circumstances, the positioning of the portfolios would align with the strategic allocations in the glide path. Implementing active asset allocation in Fidelity s target date strategies With a view and conviction established from our research, we determine the sizing and implementation of an active allocation position in relationship to the strategic glide path. Given the fact that risk and the risk capacity of investors at various stages of the lifecycle is one of the pillars of Fidelity s glide path, our implementation of active asset allocation begins with the consideration of portfolio risk. The strategic glide path provides a foundation for expected long-term asset allocations and portfolio risk (i.e., standard deviation of returns), which is gradually reduced as a target date fund investor moves closer to and into retirement. The glide path s asset allocation and resulting level of portfolio risk serve as benchmarks for the strategies, and a baseline or reference point against which active allocation decisions are measured. 5 Historically, the positioning of the target date strategies has been managed to align portfolio allocations with the strategic glide path targets to stocks, bonds, and short-term assets, with differences limited to a rebalancing range. Allocations to additional asset classes such as commodities, high-yield debt, and emerging-market debt were considered to help improve diversification and investor outcomes (see Exhibit 3, left). With the additional flexibility of active asset allocation, Fidelity s target date portfolio managers may modify the portfolio allocations relative to the glide path. The investment process provides latitude to adjust a portfolio s asset allocation by up to 10 percentage points (higher or lower) relative to the strategic glide path across the major asset classes equities, bonds, and short-term debt. 6 While this is the maximum range, we expect most portfolio adjustments to be well within this range. Because each target date portfolio maintains a different strategic allocation based on age, capacity for risk, and other factors for a broad population of investors, shareholders can expect the magnitude of our active asset allocation adjustments to be proportionate with each portfolio s exposure based on its target date. While active asset allocation adjustments may incrementally increase or decrease risk in each of the target date portfolios over the 3

4 intermediate term, the target level of portfolio risk will remain in line with the long-term structure and integrity of the glide path over long-term periods (see Exhibit 1, page 1). Active asset allocation: An evolutionary step for Fidelity s target date strategies Fidelity maintains an unwavering commitment to its target date strategies, as they serve as foundational investments to help investors achieve their retirement goals. Historically, our target date strategies have been managed to align with the strategic asset allocation of our glide path, and to leverage Fidelity s fundamental research and security selection as the primary source of added relative value. Going forward, the additional flexibility of active asset allocation provides our target date portfolio managers with greater opportunity to add value to investors. This flexibility is intended to complement fundamental security selection, which has long been the foundation of our investment organization. Active asset allocation can be influential in a variety of market environments. For example, during the past several years, macroeconomic factors became a more influential determinant of returns (e.g., risk on/risk off market volatility), highlighting the importance of asset allocation research in portfolio decision making. This period has featured unusual central bank policies (e.g., quantitative easing), a global recession, and two cyclical equity market downturns. These macro events often prompt an episodic dislocation of asset prices. We believe adding more flexibility that allows our target date managers the opportunity to increase returns through active asset allocation is an evolutionary step that can result in better retirement outcomes for investors. Authors Brett Sumsion, CFA Brett Sumsion is a portfolio manager for Fidelity Investments. Mr. Sumsion currently co-manages several multi-asset-class portfolios, including target date strategies. He joined Fidelity in Andrew Dierdorf, CFA Andrew Dierdorf is a portfolio manager for Fidelity Investments. Mr. Dierdorf currently co-manages several multi-asset-class portfolios, including target date strategies. He joined Fidelity in Mathew Jensen, CFA Director, Target Date Strategies Mathew Jensen is the director of target date strategies in the Global Asset Allocation (GAA) division of Fidelity Investments. Mr. Jensen leads investment strategy execution and product design and innovation across the company s target date offerings, and directs target date investment research and thought leadership. Vice President of Investment Capability Management Michael Tassinari contributed to this article. Fidelity Thought Leadership Vice President and Associate Editor Kevin Lavelle provided editorial direction.

5 Before investing in any mutual fund, consider the investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully. Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities. Views expressed are as of the date indicated, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information. Past performance is no guarantee of future results. Neither asset allocation nor diversification ensures a profit or guarantees against a loss. Unless otherwise disclosed to you, in providing this information, Fidelity is not undertaking to provide impartial investment advice, or to give advice in a fiduciary capacity, in connection with any investment or transaction described herein. Fiduciaries are solely responsible for exercising independent judgment in evaluating any transaction(s) and are assumed to be capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies. Fidelity has a financial interest in any transaction(s) that fiduciaries, and if applicable, their clients, may enter into involving Fidelity s products or services. Investment decisions should be based on an individual s own goals, time horizon, and tolerance for risk. Nothing in this content should be considered to be legal or tax advice and you are encouraged to consult your own lawyer, accountant, or other advisor before making any financial decision. Target date portfolios are designed for investors expecting to retire around the year indicated in each portfolio s name. Each portfolio is managed to gradually become more conservative over time as it approaches its target date. The investment risk of each target date portfolio changes over time as the portfolio s asset allocation changes. The portfolios are subject to the volatility of the financial markets, including that of equity and fixed income investments in the U.S. and abroad, and may be subject to risks associated with investing in highyield, small-cap, commodity-linked, and foreign securities. Principal invested is not guaranteed at any time, including at or after the portfolios target dates. Target date portfolios are designed to help achieve the retirement objectives of a large percentage of individuals, but the stated objectives may not be entirely applicable to all investors due to varying individual circumstances, including retirement savings plan contribution limitations. Capital market assumptions are forward-looking statements, which are based upon certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different than those presented. Endnotes 1 For more details on Fidelity s glide path, see Fidelity Leadership Series paper Target Date Evolution: Enhancements to Fidelity s Strategies, Feb Fidelity s glide path targets a 50% income replacement goal. This is informed by our views on risk capacity, capital market assumptions, and actual participant experiences. It also takes into account other key assumptions, including a contribution starting age of 25, a retirement age at or near 65, and beginning contributions of 8% that gradually increase to 13% during one s working years. These assumptions do not reflect the behavior of any specific participant. The stated goal may not be applicable or appropriate due to varying investor circumstances. Fidelity s ability to meet the stated goal is dependent on investment performance as well as contribution and withdrawal behavior. Deviation from the stated assumptions may contribute to income replacement levels lower than the stated goal. Note: No income replacement rate is guaranteed by any Fidelity target date portfolio. 3 See endnote 1. 4 Investors should allocate assets based on individual risk tolerance, investment time horizon, and personal financial situation. A particular asset allocation may be achieved by using different allocations in different accounts or by using the same allocation across multiple accounts. The glide path is not intended as a benchmark for individual investors; rather, it is a range of equity, bond, and short-term debt allocations that may be appropriate for many investors saving for retirement, based on an assumed retirement age of 65, as well as a range of expected retirement ages at or near 65. Investors should consider whether they anticipate retiring significantly earlier or later than age 65, and should select an allocation that best meets their individual circumstances and investment goals. 5 See Fidelity Leadership Series paper, Target Date Evolution: How Risk Capacity Analysis Differentiates Fidelity s Glide Path, Feb Fidelity s target date strategies allow for the portfolio managers to adjust the extended asset classes of the glide path +/- 10 percentage points for each individual asset class, but not more than 25% collectively. These include: inflation-protected debt, high-yield debt, floating-rate debt, emerging-market debt, real estate debt, and commodities. For the most aggressive Fidelity target date portfolios, the asset allocation adjustment range for equities is five percentage points. Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities. Third-party marks are the property of their respective owners; all other marks are the property of FMR LLC. If receiving this piece through your relationship with Fidelity Institutional Asset Management (FIAM), this publication may be provided by Fidelity Investments Institutional Services Company, Inc., Fidelity Institutional Asset Management Trust Company, or FIAM LLC, depending on your relationship. If receiving this piece through your relationship with Fidelity Personal & Workplace Investing (PWI) or Fidelity Family Office Services (FFOS) this publication is provided through Fidelity Brokerage Services LLC, Member NYSE, SIPC. If receiving this piece through your relationship with Fidelity Clearing and Custody Solutions or Fidelity Capital Markets, this publication is for institutional investor or investment professional use only. Clearing, custody or other brokerage services are provided through National Financial Services LLC or Fidelity Brokerage Services LLC, Member NYSE, SIPC. 5

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