Rethinking Glide Path Design — A Holistic Approach

Introduction

Target date funds have become one of the key investment products within retirement plans, often used as the main investment strategy for many plan participants. A key differentiating feature among the many available target date funds — and a primary determinant of their returns and volatility — is their glide path. A target date fund’s glide path reflects how its allocation to equity and fixed income investments changes over time in accordance with the risk-return profile of plan participants as they age. Given the prospect of discontinued labor income at retirement, investors in target date funds will commonly experience a decreasing exposure to equity markets throughout their working careers.

The investment goal of most retirement plan participants is a dual mandate: maintaining one’s lifestyle in retirement while also not outliving one’s assets. A glide path design should aim to reconcile these objectives with the appropriate level of portfolio risk at every stage in the life cycle. The construction and management of a glide path depends on a manager’s overarching philosophy and objectives. As shown in Figure 1, the target date fund industry currently employs a wide range of glide paths, with different beginning and ending equity allocations as well as different rates of equity reduction over the life cycle.

Figure 1. Target Glide Paths Differ Significantly among Managers

Source: Morningstar Direct as of 12/31/2020. Industry average reflects stock weights for mutual fund and variable annuity providers. Equity allocations based on years to target (YTT) stock glidepath data in Morningstar Direct. These data may differ from Morningstar analyst reports, which combine stock and other. Exclusions include Invesco Balanced-Risk Retirement Series, Fidelity Simplicity RMD and Fidelity Managed Retirement.

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In recent years, the industry has engaged in spirited debate over such target date topics as “to” versus “through” glide paths, open versus closed architecture and active versus passive strategies. The significant impact of glide path design on long-term results and the wide differences among glide paths within the industry raises a number of important questions: what are the main drivers of a glide path’s design, and how can the main objective of a glide path — to provide plan participants with successful retirements — be measured and evaluated over a life cycle?

This paper addresses both questions to demonstrate the process of glide path design in a holistic fashion that incorporates the participant profile into investment decisions.

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1 Participant utility is the economic concept of individual rational preferences for one choice over another and the resulting marginal benefit or cost.

2 While balancing the tradeoff between expected IRR and worst IRR outcomes is not precisely equivalent to our objective of expected utility maximization, these two concepts are roughly comparable, and we feel that this is a more intuitive way of visualizing the differences between glide path outcomes. “Worst IRR outcomes” in this paper is defined as the expected shortfall for the worst 5% of possible outcomes as calculated using the conditional value at risk (CVaR) approach.

3 J.F. Cocco, F.J. Gomes and P.J. Maenhout (2005). “Consumption and Portfolio Choice over the Life Cycle.” Review of Financial Studies, 18(2), 491-533.

4 For all calculations in this document, we assume global equity and global bond risk premiums based on Voya Investment Management’s long-term capital market forecasts.

5 See our annual long-term capital market forecasts for further description.

6 Tullio Jappelli and Luigi Pistaferri, 2010. “The Consumption Response to Income Changes,” Annual Review of Economics, vol. 2 (1), pages 479-506, 09.

7 U.S. Dept. of Labor, Bureau of Labor Statistics, Occupational Employment Statistics.

Disclosures

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General Risk(s): All investments in bonds are subject to market risks. Bonds have fixed principal and return if held to maturity, but may fluctuate in the interim. Generally, when interest rates rise, bond prices fall. Bonds with longer maturities tend to be more sensitive to changes in interest rates. All equity investing involves risks of fluctuating prices and the uncertainties of rates of return and yield inherent in investing. Foreign Investing does pose special risks including currency fluctuation, economic and political risks not found in investments that are solely domestic. Emerging market stocks may be especially volatile. Stock of an issuer in a fund’s portfolio may decline in price if the issuer fails to make anticipated dividend payments because, among other reasons, the issuer of the security experiences a decline in its financial condition. Securities of small- and mid-sized companies may entail greater price volatility and less liquidity than investing in stocks of larger companies. There are no guarantees a diversified portfolio will outperform a non-diversified portfolio.

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