Target-Date Funds: Tactical Shifts Can Add Value

April 30, 2013

Retirement-date funds—which offer a diversified, risk-sensitive approach to building retirement savings—have grown dramatically in popularity with investors since introduced a decade ago.

T. Rowe Price Retirement Funds are made up of as many as 18 different stock and bond funds. The mix of these funds is managed along a “glide path” that shifts investors’ asset allocations away from stocks into bonds as they approach their target date, or approximate age of retirement, and beyond.

However, many investors in these funds may not know that—in an effort to enhance returns or reduce volatility—the asset mix within these portfolios also is incrementally shifted from time to time to take tactical advantage of market conditions.

“We are not timing the market,” says Jerome Clark, manager of the Retirement Funds, “but we are searching for overvalued and undervalued sectors and then positioning portfolios to best capitalize on potential opportunities in the coming 12 to 18 months.”

While important, such tactical shifts tend to be incremental—small movements over time, not big, sudden shifts.

For example, the “neutral weight” for equities in the Retirement 2025 Fund at the end of the first quarter of this year was 76.0%, based on the glide path. However, at that time, the fund had 78.5% in stocks, or tactically 2.5 percentage points more.

That overweighting of stocks was based on senior investment managers’ view that stock valuations were reasonable relative to the higher valuations of bonds.

The range of these tactical adjustments is limited to no more than five percentage points for such broad asset classes as stocks and bonds. That is, if a fund’s neutral weight is 60% stocks, then the tactical adjustment could shift that weight within a range of 55% to 65%. The underlying stock fund investments are adjusted proportionately.

While the biggest contributor to the Retirement Funds’ performance over time tends to be the performance of their underlying funds, as much as 25% of their long-term performance relative to their benchmarks may stem from such tactical positions, Mr. Clark says.

The Committee

The process behind these tactical allocations was developed in 1990 with the T. Rowe Price Spectrum Funds, another series of asset allocation funds, and has evolved over time.

Driving the tactical shifts is the T. Rowe Price Asset Allocation Committee, composed of 12 of the firm’s senior investment managers.

Starting with bottom-up sector views, the group meets monthly to review stock and bond valuations, trends, and metrics to assess relative values. The committee weighs tactical positions along nine different asset class continuums, such as, most broadly, stocks versus bonds or, relatively narrowly, U.S. investment-grade debt versus foreign bonds.

“Tactical shifts give us another tool to potentially enhance return by taking advantage of changing market conditions,” Mr. Clark says. “It enables us at certain times to position the funds slightly more defensively, or more aggressively, or in between.”

The principal value of the Retirement Funds is not guaranteed at any time, including at or after the target date, which is the approximate date when investors turn age 65. The funds invest in a broad range of underlying mutual funds that include stocks, bonds, and short-term investments and are subject to the risks of different areas of the market. The funds emphasize potential capital appreciation during the early phases of retirement asset accumulation, balance the need for appreciation with the need for income as retirement approaches, and focus more on income and principal stability during retirement. The funds maintain a substantial allocation to equities both prior to and after the target date, which can result in greater volatility.

Diversification cannot assure a profit or protect against loss in a declining market.

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