PLANSPONSOR - October-November 2022 - 19

INVESTMENTS |COVER STORY
Tactical allocations have pros and cons, from a sponsor
perspective. " The pro is that, if the investment managers do get
the [tactical] calls right, it pays off for investors, " Pacholok says.
" But the con is that they could totally miss the mark. As a sponsor,
you have to decide, do you think it's worth taking that risk? "
The Callan GlidePath Funds have no tactical allocation, due
to the risk of this shorter-term strategy performing poorly, says
Mark Andersen, senior vice president and manager, trust advisory
group, at Callan in San Francisco. If a plan's target-date fund
family does have a tactical allocation, he adds, " The plan sponsor
needs to understand the process by which these tactical allocations
are made and the magnitude of the tactical bands: How big
can the tactical allocations be, measured as a percentage away
from the strategic allocation targets? And how does the manager's
approach to tactical allocations change over time, or not? "
O'Toole stresses that the Freedom Funds' managers make
long-term strategic allocations with different kinds of market and
economic environments in mind, and strategic allocations play a
bigger role in how the funds perform. Given the uncertain longerterm
capital markets outlook, in 2021 the funds increased diversification
by adding international bonds as an asset class, increasing
U.S. inflation-protected and nominal bonds, reducing U.S. investment-grade
bonds, and decreasing short-term debt holdings.
" We always remind plan sponsors that we're investing for
a very long-term time horizon, " O'Toole says. " Obviously, volatility
is uncomfortable for participants and sponsors. But earning
returns in the market does require bearing some risk, and our
glide path is designed to endure periods of volatility. We incorporate
investments that we believe will compensate investors over
time for bearing that market risk. "
Strategic Diversification
In terms of strategic allocations, equity exposures can vary widely
by cyclicality, volatility and the ability to mitigate downside risk,
Dessner says. American Funds' TDF managers intentionally
change the equities exposure over the participant life cycle, she
says. " In the early stages, when participants have a longer time
horizon and can tolerate volatility, we are more growth-oriented.
As people get closer to retirement, it's not just that we have fewer
equities. We move more into lower-volatility, higher-dividendyielding
equities. At that point, we think the allocations have to
be much more defensive exposures. "
A plan sponsor should take time to understand the methodology
for the equity exposure that the plan's target-date funds
have, Andersen says. This means, in part, grasping how and why
a manager deviates from an index in a particular asset class.
The Callan GlidePath Funds' managers have maintained two
primary equity deviations over the long term, for example.
" We are overweight to U.S. equities relative to the global
equities benchmark, " Andersen continues. " U.S. retirement
savers, for whom we feel like we are working, spend U.S. dollars
" ... there's a need for
an ongoing close look
at the target-date
manager, and that
requires a look at the
glide path structure
and investment
philosophy. "
in retirement, and we think that U.S. bias in the allocation
makes sense. Our equities mix increases the bias to the U.S. as
retirement approaches. And we have a bias to smaller-cap equities.
The thinking is that small-cap provides higher returns in
the long term, albeit at a higher volatility, and retirement savers
with a long-term focus can handle that volatility. Also, we think
that small cap is a better place [than large cap] to utilize active
management. "
Within fixed income, broad diversification has become
crucial amid interest rate shifts and economic uncertainty. In
recent years, an investor could just put money in a core bond
index fund and get a consistent return. Asked whether fixedincome
diversification has gained significance, Andersen says,
" Yes, emphatically. Having diversification in fixed income has
been really important, both across nominal [conventional] bonds
and inflation-sensitive bonds, and a mix of bond durations
between shorter term and longer term. "
For sponsors eyeing recent volatility, fixed-income diversification
has become more of a forefront concern, Pacholok says.
" You have to ask yourself, what role is fixed income playing in
your target-date fund portfolios? " she says. Do a plan's TDFs hold
mostly core fixed-income funds aimed at preserving capital and
limiting volatility, or do they also invest much in holdings such
as emerging-market debt that can bring both higher returns and
higher volatility? " Understanding what you want from the fixedincome
portfolio is becoming more of a key question for plan
sponsors, " she adds.
The recent inflation spike has brought the issue of diversifying
into inflation-sensitive investments to the forefront.
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