What It Means To Be Dynamic

Glenn A. Dial | 05/25/2017
What It Means To Be Dynamic

Summary

Target Date Funds (TDFs) have transformed retirement investing, but the static approach to the glidepath leaves many investors at risk. A more dynamic strategy is needed, and Glenn Dial says it all begins with defining what dynamic investing actually is.

TDFs: Better Outcomes, but Still Not Good Enough

Ever since 401(k) plans and their defined contribution peers, such as 403(b) and 457 plans, began to dominate the retirement plan landscape, the single biggest product advancement has been the launch of target date fund (TDFs) in 1993. These funds took the guesswork out of self-directed asset allocation by employees, which too often leads to a wildly inappropriate mix of investment choices and risk profiles.

Since no standard definition of dynamic investing exists in the industry, its meaning gets murky

 A suitable allocation mix is based on sound reasoning—rooted in modern portfolio theory—of how an investor should be positioned among stocks and bonds during the various phases of life leading up to retirement. This asset mix, however, relies heavily on actuarial assumptions without managing for other critical factors such as market performance.

As employees transition from the investing phase to the spending phase of their retirement journey, TDFs with high equity exposure could leave employees vulnerable to too much risk. For those unfortunate employees who retire at a time of market stress, this could lead to significantly lower account balances at retirement. This outcome forces employees to choose between lower income throughout retirement or remaining in the workforce longer than anticipated.

Approaches to TDF Glidepath Implementation

Early entrants into the TDF market relied exclusively on diversification to mitigate against risk, and for many decades diversification was an effective enough tool. The idea that diversification alone can enhance returns and lower risk, however, hasn't played out as planned. In times of market stress, asset classes once thought to be complementary have shown much closer correlations than in the past as stocks, bonds and even many alternatives such as real estate moved in lock-step direction on changing economic conditions.

Dynamic investing means to take action based on market realities by managing the glidepath accordingly

The realities of retirement investing have changed, and with them the strategies on how to maximize return and minimize risk. TDFs have responded to meet these realities, evolving from a static glidepath approach to ones that incorporate a greater degree of flexibility. Here's a closer look at three main strategies used in managing the glidepath:

Static – The first generation of TDFs was simplicity at its best: Establish a predetermined glidepath in which the asset mix would steadily and automatically shift from being predominantly equities to being more heavily weighted to fixed income the closer an employee got to retirement. Using this approach, employee asset allocations would be calculated and locked-in over 40 years in advance of retirement age.

A dynamic approach seeks to participate more fully in rising markets and preserve capital to a greater degree in declining ones

Tactical – While a static glidepath seeks to provide the appropriate asset mix at any given point in time, the asset allocation never takes into account market conditions. An element of flexibility is needed and a tactical approach can deviate by 5-10% in either direction of the glidepath. However, these minimum bets are rarely meaningful enough to increase the reliability of achieving retirement income goals.

Dynamic – Starting with the idea of being tactical but adding much more flexibility to the glidepath is a dynamic approach. With the ability to deviate meaningfully from the strategic asset allocation, a dynamic approach has the potential to more fully participate in rising markets while preserving principal to a greater during periods of volatility. The ultimate goal is to significantly improve retirement outcomes by making the glidepath much more actionable.

Dynamic Means Decisive Action

At its core, dynamic investing means to take action based on the realities of the markets and actively managing the glidepath in accordance with current market trends. The idea driving this approach is that asset classes exhibit both trending and mean-reverting return patterns, the cyclicality of which can be captured by a sophisticated blend of trend-following and mean-reverting allocation responses.

The ultimate goal is to improve retirement outcomes by making the glidepath much more actionable

By combining these aspects together and actively managing them along a TDF glidepath, the resulting strategy seeks to balance as many return-seeking assets as possible with as many safe assets as necessary. And in the uncertain investment environment in which employees must contend, a dynamic approach could make all the difference in ensuring a rewarding retirement.

About Dialed In to Retirement
Dialed In to Retirement offers thoughtful insights from our US head of retirement strategy on ways to improve outcomes for plan participants, including analysis of emerging retirement trends, portfolio construction ideas, regulatory developments and behavioral finance research.


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Expert-Image

Glenn A. Dial

Managing Director, Head of Retirement Strategy
New York, New York
Mr. Dial is a managing director with Allianz Global Investors, which he joined in 2011. As Head of Retirement Strategy, he is responsible for overseeing the firm’s strategic planning for the US defined contribution channel. He previously held senior-management positions with JPMorgan, Merrill Lynch and Ceridian. Mr. Dial is a co-inventor of the method and system for evaluating target-date funds, and is also credited with developing the target-date fund-category system commonly referred to as “to vs. through.” Mr. Dial has a B.S./B.A. in finance from the University of Central Florida and an M.B.A. from Rollins College.

How to Prepare for the Next Market Downturn

Glenn A. Dial | 07/27/2017
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Summary

Fortunate is the financial advisor bullish on US stocks in recent years. But more fortunate will be those who prepare clients for the inevitable market downturn. This is one of the most important things an advisor can do says Glenn Dial, and now is the time.

When the bull market ends

It's been a spectacular summer so far for stocks. In July, the S&P 500 Index and Dow hit new highs in a bull market still going strong eight years on, the second longest bull market on record. Retirement investors with an overweight to US stocks in recent years have been richly rewarded. But whether this performance can continue through the rest of the summer and beyond is anyone's guess. The only thing certain is that every bull market eventually ends, and the sooner financial advisors prepare for this inevitability, the better.

At this stage in the bull market, valuations rising to all-time highs are just one part of the story. Another part is that volatility, as measured by the CBOE Volatility Index (VIX), also known as the "fear index," has fallen to near all-time lows. This curious combination of high valuations and low volatility is a sign that investors have perhaps become too complacent. Sudden reversals in both have a tendency to catch investors by surprise, and too often without a plan for action. This is particularly true for 401(k) investors that have been defaulted into a Target Date Fund (QDIA investors), many of whom don't actively monitor their investments or market exposures.

A curious combination of high valuations and low volatility is a signal that investors have become too complacent

To see how shocking a reversal could be for retirement investors, think back to 2007 when rumblings in the US mortgage market transformed into a full-blown global financial crisis and the S&P 500 Index went on to fall 56% from peak to trough. This precipitous drop was particularly difficult on investors nearing retirement as 401(k) account balances plummeted. The result was soon-to-be retirees with a much more uncertain future than they envisioned a mere few months ago. And if that wasn't bad enough, many prospective retirees couldn't retire at the designated date after all.

In the last bear market during 2007-2009, the S&P 500 Index plummeted 56% from peak to trough

Preparing your practice

Before you set about preparing your clients for the inevitable market downturn, good form requires that you first prepare your practice. Begin by reviewing your book of business to see who's overexposed to overvalued areas of the market. The strong run-up in stock prices during this eight-year run have skewed allocations towards equities, either because rebalancing hasn't been disciplined enough, or the portfolio purposely set out to participate more fully in market gains. Either way, these clients could be much more exposed to risk than they realize.

It's here where the investment policy statement (IPS) comes into play as a guide to allocations, time horizons and risk levels. But just as important, the IPS should also serve as a guide in a market downturn, stating what asset classes, allocation ranges and risk profiles are acceptable. The IPS should also set the stage for a portfolio stress test through various market scenarios—what would a 20, 30 or even 50% decline in the S&P 500 mean for the portfolio? The answers could come as a shock, but it's better to talk about it now than after stocks begin a long fall from their peak.

An IPS should serve as a guide in a market downturn, stating what asset classes, allocation ranges and risk profiles are acceptable

In times of severe market stress

In times of sudden and severe market stress, unprepared retirement investors often make poor, costly investment decisions at the worst possible times, usually near a market bottom. Not only do they lock in losses, but many also miss out on the recovery and rally that has followed every bear market.

It's important to keep in mind that while the S&P 500 Index plummeted 56% during the 2007-2009 bear market, the index went on to gain over 250% and counting in the subsequent bull market, 2009—present. The key here is to prioritize an investment strategy that keeps investors in the markets by limiting the impacts of down markets.

Striking a cautious note for the future is to take nothing away from the present, where many retirement investors are still experiencing strong market gains. But proactively communicating about the next bear market right now engages concerns upfront, sets expectations, and provides a definitive plan of action going forward. This leads to less anxious and more confident clients when the rest of the market is panicking on the way to the exits. And ultimately, it leads to a more solid and dedicated book of business that will be there for you when the next bull market begins. 

About Dialed In to Retirement
Dialed In to Retirement offers thoughtful insights from our US head of retirement strategy on ways to improve outcomes for plan participants, including analysis of emerging retirement trends, portfolio construction ideas, regulatory developments and behavioral finance research.


105007

Expert-Image

Glenn A. Dial

Managing Director, Head of Retirement Strategy
New York, New York
Mr. Dial is a managing director with Allianz Global Investors, which he joined in 2011. As Head of Retirement Strategy, he is responsible for overseeing the firm’s strategic planning for the US defined contribution channel. He previously held senior-management positions with JPMorgan, Merrill Lynch and Ceridian. Mr. Dial is a co-inventor of the method and system for evaluating target-date funds, and is also credited with developing the target-date fund-category system commonly referred to as “to vs. through.” Mr. Dial has a B.S./B.A. in finance from the University of Central Florida and an M.B.A. from Rollins College.
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