PLANSPONSOR - August/September 2020 - 43

INVESTMENT FOCUS
and take greater credit risk. "
The Federal Reserve's concerted
actions to support the economy and
markets after the global financial crisis-
actions that were recently redoubled to stave
off a COVID-19 depression-have brought
U.S. Treasury bond rates to all-time lows
and pulled down the credit markets with
them. " There aren't many options today for
investing for yield, " Camden says.
The reduced freedom poses a
dilemma, says David O'Meara, investments
director at consulting firm Willis
Towers Watson in New York City. " Do we
increase risk in our portfolios to earn the
returns to which we have become accustomed?
Or do we change our expectations " -that
is, budget for lower income
and spending in retirement- " because
we're at a point in our lives where we
cannot withstand the increased risk?
" We fall in the latter camp. We
have to get comfortable with that lower
return, " O'Meara says.
" Investors will need to be comfortable
with lower returns for high-quality
fixed income, " says Eric Mogelof, head
of U.S. Global Wealth Management at
PIMCO in Newport Beach, California,
and a managing director of the firm.
" With the understanding that the returns
will likely be lower, we think it's still
important to incorporate investmentgrade
bonds into portfolios-they deliver
stable income and tend to offset equity
risk in market downturns. "
Yet, for investors wanting to take
higher risk but not willing to hold a large
amount of stock, bonds do offer some
higher-yielding opportunities. " In our flagship
bond strategy, we're perfectly willing
to own some U.S. high-yield corporates and
some emerging market debt, " says Peter
Chiapinelli, member of the asset allocation
team at investment manager GMO in
Boston. " The yield spreads over Treasurys
are reasonable today-they're defaultable
assets, but you're being compensated for
that. " He adds that, as of late July, the firm
owned no U.S. equities or government
bonds, finding them too expensive.
" Maybe it's time to explore emerging
market debt or areas of the market that
are not as liquid, such as bank debt, " says
O'Meara. " Or dip down in credit quality
but in a way that investors are adequately
paid for the risk. That may not be in
corporate bonds anymore. "
" I am not a fan of creativity with fixed
income, because the more creative you
get, the more speculative it becomes, " says
Steve Vernon, an actuary and consulting
research scholar at Stanford Center on
Longevity, in Stanford, California. " I
would stick with high-grade corporates
and Treasurys, and, if you're going to
take a lot of risk, you may as well do it in
the stock market. "
Vernon advises those approaching
retirement-the DC " red zone " -to view
their assets beyond the DC plan. As Social
Security makes up a large fraction of most
people's retirement income and is essentially
a bond, he says, " Do you really need
more fixed income? The answer could be
yes, but instead of buying bonds, consider
a fixed annuity. With an additional layer of
guaranteed income " -likely to yield more
than a bond fund, owing to the workings
of annuities- " [annuities] might go
50% or 75% in the 401(k) portfolio, which
might translate to 15% or 20% in stocks
for the overall portfolio. "
There are plenty of high-yield and
emerging market bond funds available,
but DC plan sponsors might be reluctant
to offer investment options dedicated
solely to higher-risk bonds. " High-yield
corporates can offer some good value,
but it's difficult to put that in the hands
of individual investors-it needs to be
professionally managed, " says Mary Ellen
Stanek, chief investment officer (CIO) at
NEXT STEPS
* Review with your consultants and advisers their long-term capital
market return assumptions, and estimate the returns your plan's fixedincome
options are likely to provide.
* For any new, higher-risk bond options being considered, carefully
review their performance during volatile periods such as 2008, 2016
and early 2018.
PLANSPONSOR.COM August - September 2020 43
Baird Advisors in Chicago.
There are engineered solutions,
however, that combine higher risk with
safer assets. PIMCO's Total Return Fund
held about 5% of assets in high-yield
corporates and emerging markets at midyear.
About 52% of assets in J.P. Morgan
Asset Management's Income Fund were
rated below investment grade, including
20% in corporate high yield. Baird's Core
Plus strategy can own up to 20% of assets
rated below investment grade, but, as of
late July, it allocated just 3%.
Northern Trust has devised a retirement
income strategy for the low-yield
environment. " It's a new phenomenon, "
Camden says. " It holds 30% equities and
70% bonds but is designed to achieve
return like a 60%/40% portfolio, yet
taking much less risk. " The bond portion
has about 30% of the portfolio in intermediate-term
investment-grade corporates
and about as much in high-yield
corporates. " Historically, high yield has
a return profile similar to the equity
market, with about two-thirds of the risk, "
he explains. " Introducing credit risk
provides some diversification and better
compensation for the risks taken. And the
equity exposure provides potential upside
for longevity risk. "
" There are two ways to answer these
basic retirement questions, " Mogelof
says. " Being willing to take on more risk
for the opportunity of higher return or
accepting a lower level of return for the
risk you are comfortable with, in the red
zone and in retirement.
" But, " he adds, " investors should also
realize that different market environments
will emerge, and the decision doesn't have
to be permanent. " -John Keefe
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