In part 1 of this blog, we saw how falling real interest rates reduce the retirement income a given account balance can support. In part 2, we focus on how interest rate risk may potentially be managed through an income-focused asset allocation.
The S&P STRIDE (S&P Shift to Retirement Income and Decumulation) indices measure the allocation shown in Exhibit 1. The allocation has two features that differentiate it from the glide path typically followed by regular target date indices. First, in an attempt to better manage market risk, the glide path of S&P STRIDE allocates 25% of index constituents to equities at the target date (or retirement), compared to about 50% for the industry average.1 Second, the S&P STRIDE glide path includes a substantial index constituent allocation to long-maturity TIPS when approaching the target date, which is designed to help manage both interest rate and inflation risk. The S&P STRIDE allocation seeks to hedge this risk by including TIPS constituents with an interest rate sensitivity similar to the cost of 25 inflation-indexed payments starting at the target retirement date. This way, when interest rates decrease, the cost of future consumption goes up, but so does the account balance. With the appropriate TIPS portfolio, the two effects approximately offset each other, making retirement income less volatile.
How did the S&P STRIDE approach fare in 2020? Exhibit 2 considers the hypothetical experience of a cohort of investors retiring in 2020. We compare two index constituent allocations: the S&P STRIDE 2020 Index and the S&P 2020 Target Date Index, which seeks to represent the average asset allocation of U.S.-based 2020 target date funds.2 Starting with a theoretical $1M investment at the beginning of 2020, the bars show the theoretical real income that each allocation can afford, determined by balance amounts and real interest rates at the beginning of each month.
The S&P 2020 Target Date Index performance was –4.3% in theoretical real income terms in 2020. By contrast, the S&P STRIDE 2020 Index performance was 1.6%, an outperformance of 5.9 percentage points. Importantly, this difference was not driven by the S&P STRIDE Index’s lower exposure to equities. Given that equity markets rebounded substantially since March 2020, this outperformance may be attributed to S&P STRIDE’s long-dated TIPS allocation. While bond constituents in the S&P 2020 Target Date Index offered some protection from interest rate risk, their maturities were too short to fully offset the theoretical income loss.
As eventful as 2020 was, S&P STRIDE Index’s income-focused approach proved its potential as a tool to help mitigate interest rate and inflation risk.
1 Figure based on the S&P Target Date 2020 Index, which reflects the average asset allocation across 2020 target date funds. See S&P Target Date Scorecard Year-End 2019 (link) and S&P’s “Making STRIDEs in Evaluating the Performance of Retirement Solutions” (link).
2 See “S&P Target Date Index Series Methodology” (link) for a complete description.
Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.
The S&P STRIDE Index Series was developed in collaboration with Dimensional Fund Advisors LP (“Dimensional”), an investment advisor with the U.S. Securities and Exchange Commission. Dimensional Fund Advisors LP receives compensation from S&P Dow Jones Indices in connection with licensing right to the S&P STRIDE Indices.The posts on this blog are opinions, not advice. Please read our Disclaimers.