Do Your Target-Date Funds Measure Up to Rising Rates?
Rising US interest rates could pose a challenge for target-date funds (TDFs) that concentrate on “core” US fixed-income exposure. Diversifying across a broad range of bond markets and strategies can create a cushion in a rising-rate environment.
Traditional TDFs often don’t diversify their fixed-income allocations enough, investing mostly in US aggregate bonds. These include investment-grade government, corporate and mortgage securities. With US rates seemingly headed up, this investment could be a risky bet. In reaction to the 2016 presidential election, the US bond market lost 3%* in the fourth quarter of that year. This past January, it lost 1% amid fears that faster growth and inflation could force central banks to tighten monetary policy faster than expected.
In both scenarios, traditional TDFs that were under-diversified in fixed income were shaken. Plan sponsors can ensure that their fixed-income allocations are ready to play defense in the current rising-interest-rate environment by adequately diversifying beyond traditional core US holdings.
What Does “Enough” Fixed-Income Diversification Look Like?
Many larger plans have already diversified their target date’s core bond holdings with a broader mix of fixed-income strategies, and smaller and midsized plans have started to. In our view, that diversification should be across a range of maturities, sectors, geographies and structures (Display).