How TDF Managers Are Reacting to High-Interest-Rate, Inflationary Environment

As the Federal Reserve continues to make progress in lowering inflation and is expected to slowly reduce interest rates in 2024, asset managers have different ideas as to how this will impact investments, particularly for plan participants nearing retirement. 

When it comes to asset allocations in target-date funds, the most popular investments in workplace retirement plans, asset managers at Vanguard, BlackRock and T. Rowe Price all agree that designing a glide path requires looking ahead multiple decades into the future and that current market conditions are not going to result in major changes. 

Consistent Glide Paths 

“Our approach, irrespective of where an individual sits relative to retirement, is going to be consistent,” says Kim DeDominicis, a target-date portfolio manager at T. Rowe Price, which manages about $391 billion in target date retirement products as of November 2023. 

DeDominicis says T. Rowe has a group of senior investors who meet formally on a monthly basis to determine the “tactical deviations” they think are appropriate, then apply those consistently to the target-date glide paths. These tactical decisions are based on shorter-term horizons—anywhere between six to 18 months in the future.  

For example, DeDominicis says, if a participant is invested in T. Rowe’s 2025 portfolio, they will receive the same overweight or underweight position in all asset classes as if they were in the 2060 portfolio.  

“We’ve built the glide path to be very durable and robust for those long periods of time, incorporating what we think is the right mix, not only of equities and fixed income, but within equity and within fixed income,” DeDominicis says. “Then where we are able to kind of lean in is with our tactical approach, but that’s done … in a consistent manner.” 

DeDominicis says T. Rowe’s asset allocation committee has been underweight to equities and fixed income with an overweight to cash, as cash not only provides liquidity but has been, for the first time in a long time, providing a positive yield.  

“If you look at all of 2023, and actually even back to 2022, we have maintained that underweight position to equities and fixed income,” DeDominicis says.  

Within the equity sleeve, however, DeDominicis says T. Rowe has incorporated an overweight position with the goal of hedging against persistently high inflation and any potential commodity shocks that could happen in the future. She says in the second half of 2023, the committee moved to an overweight position in real assets from being neutral.  

J.P. Morgan Asset Management similarly has taken an underweight equity approach, as well as a higher allocation to cash, in its target-date portfolios, as the Fed’s hesitance to cut interest rates has created an “awful lot of unknowns,” according to Dan Oldroyd, head of target-date strategies at J.P. Morgan. 

Varying Views 

On the other hand, Nick Nefouse, head of LifePath and head of retirement solutions at BlackRock, says BlackRock has been slightly overweight equities in its LifePath Dynamic Retirement Funds.  

“We felt that a lot of the information that we’ve seen in the market is that people have been incorrect on the call for a hard landing,” Nefouse says. “They position their portfolios more bearishly, and we’ve positioned our portfolios for more continued economic growth.” 

BlackRock manages $247 billion in institutional target-date fund assets, as of December 31, 2022, according to Morningstar. 

Despite the high-interest-rate environment in 2023, Nefouse points out that stocks still “dramatically outpaced bonds.” At the end of 2023, the S&P 500 was up 24.2%, the Dow rose more than 13% and the Nasdaq soared 43%. 

“That doesn’t mean [positive equity performance] is going to persist forever; it never does,” Nefouse says. “But we’ve been hearing this, ‘You want to allocate to bonds’ for the last year, and it just hasn’t paid off relative to equities.” 

In the last couple of years, Nefouse says BlackRock has made a few changes to its LifePath Dynamic target-date funds. The first change was launching a custom bond portfolio, allocating to a number of BlackRock’s fixed-income managers, which Nefouse says has allowed BlackRock to get more precision around the type of fixed income that it wants to own, particularly for older investors. 

In addition, BlackRock added real alternatives within the fixed-income portfolio, Nefouse explains. 

“It’s not correlated to stocks, it’s not correlated to bonds,” Nefouse says. “The reason why we’ve been doing this is another super important nuance, which is that bond market volatility remains high. So even for investors that are nearing retirement that are owning fixed income, we still see a fair amount of volatility because we haven’t really settled on what the new interest rate environment [will] look like [and] what the new inflation environment [will] look like. So we wanted to add another asset class to diversify fixed-income portfolios.” 

Nefouse says the custom bond portfolio and the new liquid alternatives have “added more quality to the portfolios,” as well as more precision and diversification.  

Fed Predictions 

Brian Miller, senior investment specialist and head of target-date product management at Vanguard, said in an emailed response that he expects the Fed will begin to lower interest rates by the end of 2024 to the 4% to 4.5% range. However, he said Vanguard does not make tactical changes to its target-date funds’ asset allocations based on short-term market conditions.  

As a result, Miller said he does not anticipate repositioning the funds in response to a decrease in the Fed’s interest-rate target.  

“All of [that] being said, a critical part of our target-date fund oversight process is continually ensuring that the Target Retirement Fund glide path and underlying sub-asset allocation continue to keep our investors on the path to a successful retirement,” Miller said. “We conduct a full glide path revalidation each year, which involves updating the capital market assumptions and investor data in our proprietary Vanguard Life-Cycle Investing Model. This data-driven exercise enables us to apply our best thinking to the funds’ existing glide path and underlying sub-asset allocation to determine if any changes would be appropriate for our Target Retirement Funds.” 

Vanguard manages $594 billion in Target Retirement Funds, and another $640 billion in Target Retirement Trusts, for a total of $1.2 trillion in its Target Retirement series. Vangaurd no longer offers the Institutional Target Retirement Funds, as they were merged into its Target Retirement Funds back in 2021. 

Miller emphasized that Vanguard believes investors should focus on the things they can control—having clear investment goals, maintaining broad diversification, keeping their investment costs low and sticking with their plan over the long term. 

While bonds, besides high yield, performed poorly at the end of 2023, looking ahead into 2024, Jack Manley, global market strategist at J.P. Morgan, said in a recent DC Quarterly Review webinar that he is more optimistic about bond performance this year than equity performance. As interest rates move lower, the value of fixed income will go up, but he said this may be short-lived and that investors should “strike while the iron is hot.”