PIMCO Updates Its 2023 Glide Path for Target Date Funds

PIMCO’s glide path for target date funds expresses the firm’s collective view on an age-appropriate asset allocation that aims to deliver successful retirement outcomes for defined contribution (DC) plan participants. Each year, we review the glide path formally to ensure it remains optimal, taking into account any recent modeling enhancements, changes in DC participant trends, and PIMCO’s latest views on asset allocation and valuations.

In this year’s update, on average, we reduced exposure to equity markets, particularly close to retirement, in favor of higher allocations to fixed income, while also refining sub-asset- class exposures based on relative valuations.

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, managing director, is lead portfolio manager on PIMCO’s RealPath Blend strategies and oversees the glide path leadership team.

Niels Pedersen and Sean Klein are executive vice presidents and senior members of the quantitative research team.

Q: What are the objectives of the PIMCO glide path?

Browne: Our glide path seeks to provide successful retirement outcomes for participants by managing the trade-off between the level of real retirement income and its volatility, or uncertainty. This requires balancing three key objectives: wealth maximization, return diversification, and retirement income hedging over the course of a participant’s savings journey. The result is a glide path that incorporates a diverse set of return drivers. For instance, PIMCO’s glide path has meaningful exposures to non-U.S. equities and spread sectors. It also has an explicit focus on mitigating real retirement income risk via greater exposures to real assets and “safe haven”^Footnote1 long-term fixed income (see Figure 1).

Q: How does the glide path review process work?

Pedersen: The annual process is rooted in PIMCO’s time- tested investment process, which for more than 50 years has managed risk and delivered returns across a wide range of market environments. The process starts with our Secular and Cyclical Forums in which PIMCO investment professionals debate and formulate outlooks for growth, inflation, potential risks, and opportunities across global economies and financial markets. (See our latest Cyclical Outlook, “Strained Markets, Strong Bonds.”) Next, PIMCO’s Investment Committee (IC) determines investment themes and portfolio risk factor targets, which form the basis of the firm’s updated capital market assumptions (CMAs).

The glide path team uses the CMAs and augments its analysis in light of retirement savings trends and modeling changes, if any, to seek an “optimal” asset allocation. The IC validates the proposed changes and, once satisfied, provides formal approval.

Q: Can you elaborate on how PIMCO’S CMAs guide the glide path process, and explain the major shifts that occurred this year?

Klein: As mentioned, one of the key inputs into our glide path review process is PIMCO’s long-term CMAs. They can be thought of as the “quantification” of our firmwide views over the secular (five-year) time horizon.

Following 2022’s historic sell-off in interest rates, PIMCO’s long-term return assumptions for fixed income increased materially relative to last year. For example, our five-year return assumption for U.S. core bonds jumped from 1.8% annually at the end of 2021 to 4.5% at the end of 2022. Within fixed income, spread levels appear slightly rich, implying less favorable risk/reward prospects for corporate credit relative to a year ago.

Equity risk premiums fell from 4%–5% last year to 1%–2% today, suggesting potentially lower longer-term returns. Return expectations for commodities increased despite recent strong returns. This is due in part to supply constraints and attractive carry potential given forward-curve pricing (see our Viewpoint, “Growing Demand, Tight Supply Support Commodities in 2023”).

Q: What are the major asset allocation changes this year?

Browne: In light of less attractive equity risk premia, the glide path’s average allocation to equities decreased by 2 percentage points, with the most notable reduction in vintages closer to retirement. The glide path’s equity landing point, for example, declined from 45% to 40% while allocations to equity and fixed income at early vintages were little changed, reflecting the greater importance of return maximization for younger participants (see Figure 2).

There were also modest changes in sub-asset-class glide path exposures. Within equities, on a relative basis, developed market ex U.S. equities experienced the most notable decrease in exposure. We also implemented a small increase in exposure to emerging market (EM) equities given favorable valuations, due in part to a favorable return outlook for EM currencies.

Within fixed income, given the significant shifts in rate valuations since last year, we increased the interest rate sensitivity of the glide path, on average, especially near retirement. Additionally, we reduced exposures to spread sectors such as high yield and EM local bonds in favor of U.S. core bonds, given more attractive risk-adjusted return prospects. Given attractive pricing we also increased exposure to U.S. Treasury Inflation-Protected Securities (TIPS) on average across the glide path to help mitigate the risk of further upside surprises to inflation.

Lastly, we also reintroduced commodities, albeit as a relatively small 1% to 2% allocation across the glide path, given our constructive view on the asset class. Equally important, while commodities exhibit equity-like volatility on a standalone basis, we believe they can provide strong diversification benefits relative to traditional stocks and bonds as well as meaningful inflation-hedging qualities, especially in today’s environment. By adding commodities, and given other changes discussed above, we expect volatility of PIMCO’s glide path may potentially decline by roughly 0.5–0.6 percentage points for older participants.

Q: Does the process result in significant annual changes to the glide path?

Browne: Changes to key asset class risk factors tend to shift slowly, in line with the evolution of our long-term CMAs. Indeed, we consider this year’s enhancements to be modest. The ex ante tracking error (the expected difference in return volatility between the new glide path and the prior year’s) is between roughly 30 basis points and 115 basis points, depending on the vintage, reflecting the gradual and conservative nature of our year-over-year changes. At the same time, the changes are expected to help drive more attractive risk-adjusted returns. While shifts over time are intended to be modest, historically this process has consistently added value relative to a “set it and forget it” approach.

The authors thank Senior Advisor Steve Sapra for his contributions to this report