The fixed-income allocation is often the key differentiator among target-date strategies that appear similar in terms of equity holdings and the basic glide path strategy, according to a new analysis from J.P. Morgan Asset Management.

In a new retirement insights paper, “Three Questions for Assessing TDF’s Fixed-Income Allocation,” Dan Oldroyd, portfolio manager and head of target strategies, argues fixed-income investments play a crucial role in overall target-date fund performance. However, he commonly sees clients and industry professionals alike focusing much more on the equity holdings in TDF portfolios—perhaps based on the assumption that this part of the portfolio is always the greater source of risk and returns.

This is simply not true when one keeps in mind the very long-term nature of TDF strategies, Oldroyd warns, especially when one remembers that any given TDF may start out mainly allocated to equities—but over time the fixed-income allocation takes the lead role. Especially for investors near the retirement date, the nature of a TDF series’ fixed-income holdings can make all the difference.

“The fixed income allocation can be a key differentiator among target-date strategies, but its structure and management do not always get the attention they deserve within the TDF selection process,” Oldroyd adds.  

He points out that preferred TDF strategies may vary quite widely across plan sponsors based on participant needs, and that when selecting the best TDF for their unique participants, plan sponsors should consider three things. First, is the fixed-income portfolio sufficiently diversified? Next, does the fixed-income manager have the flexibility to enhance risk-adjusted returns? And finally, can the TDF’s fixed-income portfolio help weather a rise in interest rates or other changes in the economic and investment environment?”

Oldroyd observes that most investors understand the basic idea that a well-diversified equity allocation may be able to deliver more consistent risk-adjusted returns across a wider range of investment environments than a more narrowly diversified, concentrated allocation. Yet fewer people seem to grasp that the selfsame factors apply to the fixed-income markets—that there are many different types of bonds holdings one can purchase, and many different ways to organize them in pursuit of the efficient investing frontier.

And just like on the equities side, the J.P. Morgan analysis goes on to argue that “skilled active fixed-income managers generally have greater flexibility and more tools than passive managers for generating strong risk-adjusted returns over time. Replicating a fixed-income index can be more complex, costly and subject to structural bias, and involve more active decisionmaking, than some investors realize.”

Concluding with some important context, Oldroyd suggests that interest rates are widely expected to climb higher during the rest of 2017. And so retirement plan investors “should ensure TDF strategies can adapt to such changes and represents a reasonable compromise between controlling costs and providing participants with the potential for a smooth path to a financially secure retirement.”

Additional research and information from J.P. Morgan Asset Management is available here.