PLANADVISER - November/December 2020 - 35

investment-oriented
Then, there is inflation: A surprise jump in the price of
a retired lifestyle erodes assets further. For one example, as
summarized by a 1994 article in the Journal of Financial
Planning: In the market and economic downdraft of 1973
through 1974, U.S. stocks fell 37%, while consumer prices
rose 22%; bonds offset those losses by just 11%.
All of this is complicated by individuals' choices on
when to retire and their spending patterns. So the risks
to retirees are not just in returns. Perhaps a better way to
express this passel of challenges, and the time at which
they arise, is simply sequence risk.
Means of Protection
Retiree portfolios can be protected in many ways. " A
manager can run a portfolio that includes insurance, by
buying put options to hedge equity volatility, or inflation
protection over the entire glide path of a target-date fund
[TDF], " observes Dan Oldroyd, head of target date strategies
at J.P. Morgan Asset Management in New York City. " But
with puts, you pay a premium; with TIPS [Treasury inflation-protected
securities], there is a give-up in yield; and
commodities bring volatility. "
Reducing equity market exposure in the ramp-up
to retirement and diversifying to other assets is widely
accepted for managing sequence risk, and is part of the
proposition of TDFs. But that tactic has limits. " Moving an
age group from 90% equities early on to 50% near retirement
doesn't really reduce the risk all that much, because
participants have their highest balances, " reiterates Lloyd.
Mercer's research looks at whether fund managers incorporate
analysis of risky market scenarios-such as the
ruinous early 1970s- " and whether they understand how to
mitigate those sorts of serious environments. "
J.P. Morgan has studied the volatility in participants'
cash flows and finds that spending begins well before retirement,
as people shore up their homes and health care. " For
investors in their 50s, we start to build in inflation-sensitive
assets, allocating 10% to 15%, " Oldroyd explains. " In the last
five years before typical retirement age, we take risk down to
about 33% equities, with the rest in fixed income and cash. "
Fund manager Capital Group maintains equity allocations,
but changes the makeup of TDF equities into retirement,
says Rich Lang, investment director for the company's
American Funds Target Date Retirement Series, in Los
Angeles. " We move to a more dividend-paying focus-to
large blue-chip companies that historically have been more
resilient when broad equity markets have sold off. Our
funds have higher equity allocations going into retirement
than many competitors', but because it's a different type of
equity, the funds' return volatility is below average. "
'Expect Risk'
The retirement vintage TDFs of T. Rowe Price Group, Baltimore,
hold 55% equities at the time of retirement and
decline from there. " The industry average is about 45% equities, "
says Wyatt Lee, head of target date strategies, " so if the
stock market is down 20%, the difference is just 2%. But if
the extra 10% is held for a really long time in front of that
sell-off, how much have I given up?
" Risk comes in many forms, " Lee points out, " and because
stock market risk is tangible, it's easy for individuals to
grasp. But if people don't need their entire balance at one
time, the bigger concern might not be short-term volatility,
but rather not having enough growth assets to allow the
lifestyle they want. "
" Market volatility is not something to react to; it's something
to expect, " says Lee's colleague and senior DC strategist
Lorie Latham, also in Baltimore.
" ... if people don't need their
entire balance at one time,
the bigger concern might
not be short-term volatility,
but rather not having enough
growth assets to allow the
lifestyle they want. "
Steve Murray, director of asset allocation and investment
solutions at Russell Investments Group, Seattle, says
he believes in planning for such events, but not going overboard.
" There's a tendency to grant future market events a
higher probability than they've shown in the past. It's good
to give yourself flexibility, but if you plan just for the disasters,
you may not have a very successful outcome in more
typical market environments. "
In view of the many variables entering people's retirement
choices-career horizon, wealth levels, risk preferences,
life expectancies, goals and lifestyles in retirement-the
tailored approach of a managed account seems a
candidate for handling retirement assets.
Edelman Financial Engines, Palo Alto, provides managed
account services to 1.2 million people in DC plans and offers
a version specific to retirement, named Income Plus. " We
allocate the portfolio in such a way that it creates sustainable
income that is immunized from changes in the stock market
or in interest rates, " says Christopher Jones, chief investment
officer (CIO) with the firm. " It's 80% in fixed income, using
plan menu choices, and matches the duration of assets in the
portfolio to the maturity of the retiree's liabilities. "
Still, few people wanted to dedicate their entire 401(k)
balance, so the service has been refined to set aside just a
portion, as well as to accommodate higher allocations to
equities. " Some people are comfortable with a high degree
of assured income, " Jones says, " while others are willing to
take more risk for the chance that they can spend more-
realizing there's a chance they might have to reduce their
target spending. " -John Keefe
planadviser.com November-December 2020 | 35
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