PIMCO’s glide path for target date funds expresses the firm’s collective view on age-appropriate asset allocation that can help prepare defined contribution (DC) plan participants for successful retirements. The glide path is reviewed annually based on the latest information on asset valuations, modeling enhancements, DC savings trends, and PIMCO’s asset allocation views. The new 2022 glide path has a slightly higher allocation to equities, and a lower exposure to long duration and core bonds.
In the following Q&A, senior members of PIMCO’s glide path leadership team discuss the key objectives, investment processes, and results from our recently concluded review. Erin Browne is a managing director and asset allocation portfolio manager who oversees the glide path team. Steve Sapra and Niels Pedersen are executive vice presidents and senior members of PIMCO’s quantitative research team.
Q: WHAT ARE THE OBJECTIVES OF THE PIMCO GLIDE PATH?
Browne: Our glide path aims to balance the key objectives of wealth maximization, diversification, and retirement income. The glide path’s asset allocation seeks to optimally balance the trade-off between inflation-adjusted retirement income and income volatility. To achieve sufficient retirement income, a portfolio should generate adequate risk-adjusted returns over the long term and use a diverse array of investments to realize robust outcomes across a variety of economic conditions (see Figure 1).
Figure 1: PIMCO’s 2022 glide path
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Q: HOW DOES THE GLIDE PATH REVIEW PROCESS WORK?
Pedersen: The annual glide path review process is rooted in PIMCO’s overall investment process, and benefits from the firm’s over 50-year history of managing risk and delivering returns across a wide range of market environments. The process starts with our secular and cyclical forums, where PIMCO investment professionals debate and formulate our outlook on growth, inflation, risks, and opportunities across the globe. We also invite outside experts to help us avoid blind spots and mitigate biases. (See our January Cyclical Outlook.)
Next, PIMCO’s Investment Committee (IC) refines and translates forum conclusions into investment themes and portfolio targets. The glide path team incorporates the IC’s views as well as analyses of defined contribution savings trends, modeling enhancements, and asset class valuations. This year we also discussed rebalancing frequency given market volatility, and reconfirmed the value of our monthly approach. We also conducted our quarterly review of the underlying funds and all passed their screens.
As in prior years, PIMCO’s IC provides final approval, and any glide path changes are recorded and monitored over time to assess their efficacy and to continuously improve the process.
Q: CAN YOU ELABORATE ON HOW ASSET ALLOCATION VIEWS AND CAPITAL MARKET ASSUMPTIONS GUIDE THIS PROCESS?
Sapra: One of the key inputs into our glide path modeling process is PIMCO’s long-term capital market assumptions (CMAs). The CMAs can be thought of as the quantification of our firmwide views emanating from the forums. Synthesizing our long-term estimated returns with the most current data – on household savings and balance sheets (including housing wealth), savings and contribution rates, employer matches, and Social Security benefits – allows us to produce a glide path that we believe reflects the current behavior of participants and plan sponsors as well as our views on how asset class returns are expected to evolve in the future.
Given higher levels of government bond yields, our CMAs for core bonds have gone up, from around 1% a year ago to 1.8% today. However, credit spreads are meaningfully tighter than this time last year, implying that the incremental return to assuming credit risk is low, but still positive. Given the significant widening of inflation breakevens in 2021, reflecting the market’s view of higher inflation going forward, we find Treasury Inflation-Protected Securities (TIPS) and long TIPS are now priced roughly in line with their nominal counterparts.
This is a change from this time last year, when we viewed TIPS as more attractive than nominal bonds. Given the prospects for relatively high earnings growth, we view equities as somewhat attractive today. Our estimated return for large-cap U.S. equities is 6%, or 4.7 percentage points over our average cash rate estimate of 1.3% annually over the next five years.
Q: WHAT ARE SOME OF THE MAIN ASSET ALLOCATION CHANGES THIS YEAR?
Browne: Given the attractive equity risk premium Steve described, the average allocation to equities along the glide path increased by 1.6 percentage points, more notably in the middle vintages. At retirement, we view the 45% equity exposure as striking the right balance between growth potential and the need to limit downside risk; hence, exposure was unchanged (see Figure 2). There were changes in the underlying components as well: We increased exposure to U.S. large-cap and international equities across the glide path, lifted exposure to emerging market equities for allocations further from retirement, and reduced exposure to U.S. small-cap equities and U.S. real estate investment trusts (REITs) across the glide path.
Figure 2: A slight increase in equity exposure
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On the fixed income side, we slightly reduced exposure to U.S. core bonds and long-term U.S. fixed income (long Treasuries and long TIPS) across most allocations in favor of emerging market bonds and global bonds. As a result, duration (interest rate sensitivity) declined between 0.1 years and 0.5 years depending on the vintage.
Q: INFLATION IS TOP OF MIND FOR MANY INVESTORS. HOW IS THE GLIDE PATH SEEKING TO MITIGATE RISK IN PORTFOLIOS?
Sapra: It’s not just about the amount of money at retirement, but one’s ability to maintain real purchasing power, thus preserving one’s standard of living in ”the golden years.” Real assets, or assets that tend to be correlated to changes in inflation, may provide some essential inflation mitigation. Examples include TIPS, foreign currencies (which hedge import prices), and REITs. However, it’s important to consider not just an asset classes’ inflation properties, but how those attributes are valued today.
Breakeven inflation has increased considerably and is now generally in-line with our long-term inflation views. As such, as Erin noted, we’ve reduced our exposure to TIPS and long TIPS this year. However, our glide path at retirement still has an 18% allocation to these real assets – almost double the allocation in many other glide paths. Thus, while we view certain real assets as marginally less attractive today than we did a year ago, our process is designed to seek to maximize and preserve inflation-adjusted retirement income (see Figure 3).
Figure 3: Exposure to real assets has declined but remains above average
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Q: DOES THE PROCESS RESULT IN SIGNIFICANT YEAR-ON-YEAR CHANGES TO THE GLIDE PATH?
Pedersen: We generally expect changes to the balance of return-seeking and income-producing assets to shift slowly year-over-year, in line with the evolution of our long-term CMAs. This year’s modest glide path enhancements were consistent with that. The ex ante tracking error (the statistical difference between the new and the prior year’s glide paths) this year was no more than 0.75%, depending on the vintage, reflecting the gradual and conservative nature of our year-over-year changes. However, the magnitude of the changes ultimately depends on PIMCO’s views on asset market valuations and macro regimes. If macro conditions and valuations shift substantially from the prior year, the change in the risk allocation toward exposures that are deemed more attractive could be larger.
For more details on our glide path construction and modeling processes, please see our Viewpoint, “The PIMCO Glide Path Construction Process”.
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