T. Rowe's new target-date strategy differs from its flagship product by providing a lower equity allocation at retirement time and creating more predictability of returns, says manager Jerome Clark.
David Falkof: Hi, I’m David Falkof I’m a mutual fund analyst for Morningstar. And I’m here today with Jerome Clark, a portfolio manager for T. Rowe Price's Target-Date Series of funds.
Jerome, thanks for being here.
Jerome Clark: Thanks for having me.
Falkof: Jerome I wanted to talk sort of broadly about target-date funds first. Most investors are accessing target-date funds in their 401(k)s, and typically there is just one option, there may be a number of years that they are able to choose from, but there is one glide path--the mix of stocks and bonds over time. And T. Rowe, for a long time, its flagship Target-Date Series has a "through" investment option. I was wondering if you could sort of talk about the rationale behind your current flagship T. Rowe Price Target-Date Series.
Clark: Well, the current retirement fund--that’s our flagship product--is designed for lifetime income for investors. And so, with lifetime income, we’re talking about long life expectancies providing income over a long period of time. When we’re weighing the different investment risk and how we’re going to balance between market risk, inflation risk, and longevity risk, because of that focus on lifetime income, what our analysis shows us is that we need to have a tilt toward longevity inflation risk, which means we have a higher-than-average equity allocation for our funds.
Falkof: And now you’re launching a new Target-Date Series, that’s going to have a different glide path, maybe less equity exposure over time. Could you talk about the rationale behind that and some of the differences and what types of investors would be interested in this new Target-Date Series?
Clark: Sure. Well, as I said the objective of the retirement funds is to address lifetime income. This new product is to address a different objective. What we have found is that there are a fair amount of investors who are more interested, have more of a focus on maybe more moderate volatility to support a shorter withdrawal horizon for their assets in retirement. So, this product was designed for that type of investor.
Falkof: And what are some of the key differences between the two series?
Clark: Well, I’d say the beauty of it is that there is one key difference: It's the equity strategy for the two products. When you look underneath everything else, the diversification that we have within the retirement funds, it’s the exact same asset classes and sectors that are represented. It's the exact same underlying funds that are in the retirement funds which are in the new target retirement product. Then, the tactical allocations that have enhanced returns for our retirement funds over the last several years, we’re going to be applying those same tactical allocations in the exact same manner.
So, it’s really about the glide path differences. So, for example when you look at our equity strategy for both funds, they both start off at 90% equity allocation. But by the time these two different products hit retirement, our original series of retirement funds are at 55% equity allocation as opposed to the new product which has 42.5%, a 12.5% difference.
It sounds small, but is actually meaningful when you look at the outcomes and different metrics that we’re measuring for participant outcomes, or investor outcomes. And then, eventually, those two products come back together at 20 years post retirement and they continue to have the same strategy thereafter.
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Falkof: And the idea is that at retirement, these investors in the new series will have less exposure to the volatility of the equity markets?
Clark: That lower equity gives them more predictability of the returns, not necessarily better outcomes but more predictability of returns. And because they have a more moderate withdrawal horizon, that is designed to provide [that predictability] with that horizon.
Falkof: And for investors thinking about their own allocations and sort of how you've thought about how to build a broad portfolio, typically investors will have a broad portfolio of stocks, and a broad portfolio of bonds. And T. Rowe recently in the past few years added a real assets strategy to Target-Date Series. Can you explain what the Real Assets fund provides and sort of the rationale behind adding it to the series?
Clark: Well, the rationale behind it is that we found through our analysis, we have a research and development group, and they did a comprehensive study. What their study showed is that these real assets in a core portfolio to support the foundation of the other asset classes is that what they bring to the table for the investor is better behavior or better characteristics in two environments: the high inflationary environment or one where inflation is rising at a pretty good pace. In those two environments where the other components could be a challenge, what we find is these asset classes, these real assets, tend to do better and help offset some of the challenges that the other components make. So, that reduces the overall volatility for investors.
Falkof: And then lastly, T. Rowe has this tactical overlay for their Target-Date Series, and I think it’d be interesting to hear a little bit about sort of what T. Rowe, as a firm, what its view is on today’s market environment and some of the things you’re doing within the Target-Date Series to address some of the concerns that you may have about today’s market?
Clark: Probably, I would say the most significant focus we have today is when you look at today’s fixed-income environment with interest rates so low, yields so low, that for the foreseeable future, I think most investment professionals find the expectation is going to be a challenging environment for fixed income. So, when you look at the tilts that we’re making within our asset-allocation products, with our target-date products and other asset allocation products, we’re really taking that into account.
So, at one level when you look at equities versus fixed income what we’re doing is we’re tilting away from fixed income. The other thing is that when you look at what we’re doing within fixed income, not only have we reduced our exposure, our interest-rate exposure by having tilted away from fixed income, but within fixed income, we have allocations to high-yield, nondollar bonds, and emerging-markets bonds. That overall helps reduce our U.S. interest-rate risk. But then also we’re doing tactical allocations which are tilting us away from our core fixed income, which has the highest U.S. interest-rate exposure, and tilting more toward, for example, high yield and nondollar.
Then, at even another level within our core fixed income, our underlying fund manager is reducing his exposure to U.S. interest-rate risk by reallocating out of, for example, U.S. Treasuries, and into spread products and plus sectors, such as high yield and nondollar.
Falkof: Thanks, Jerome. This is really great. I appreciate you joining us.
Clark: Thanks for having.
Falkof: From Morningstar, this is David Falkof. Thanks for watching.
