trendspotting | PLANADVISER January/February 2017

A TDF With Income in Mind

Investments could include REITs and high-yield bonds.

By Rebecca Moore | January/February 2017
Art by Jackie Ferrentino

Adding a range of high-income-generating investments could significantly boost income returns for retirement-stage target-date funds (TDFs), a study suggests.

The research from Wilshire Funds Management, sponsored by the National Association of Real Estate Investment Trusts (NAREIT) was based on portfolio optimizations using 40 years of investment return data through 2015. It found that adding a range of high-income-generating assets to a traditional retirement-stage TDF portfolio could boost income returns by nearly 40%, while providing comparable total returns and no increase in risk.

Wilshire’s research is based on a variation of the mean-variance optimization (MVO) method for portfolio modelling. While traditional MVO models are designed to determine optimum levels of various portfolio assets that will produce a maximum total return for a specified level of risk, Wilshire’s income-oriented mean-variance optimization (IOMVO) model also incorporates a requirement for a specified level of income return.

Wilshire found that a traditional MVO-modeled portfolio that delivered a 2.37% annual income return and a 5.37% annual total return with an 8% level of portfolio risk could be enhanced with IOMVO modelling to deliver a greater annual income return of 3.25% and a comparable  5.27% annual total return with the same 8% level of risk.

Comparing the asset allocations between the traditional and income-oriented portfolios:

• Equity allocations were reduced from 35% of the MVO portfolio to between 3% and 15% of the IOMVO portfolio;

• High-yield bonds and preferred stocks became key parts of the IOMVO portfolio. The allocation to these assets increased from 9% to between 22.7% and 25%;

• Non-U.S. developed market stock allocations rose from 4% of the MVO portfolio to between 9% and 23.5% of the IOMVO portfolio; and

• REIT allocations rose from zero in the MVO portfolio to approximately 8% of the IOMVO portfolio.

“Depending on the income needs of the investor, portfolios that generate less income may require retirees to dig deeper and more frequently into their savings to fund their expenses, potentially resulting in the depletion of their assets while they are still living,” says Wilshire Funds Management Chief Investment Officer (CIO) Joshua Emanuel.

“Income-oriented portfolios with significant allocations to assets such as REITs, high-yield bonds, preferred stocks and non-U.S. developed stocks may help investors meet the challenge of producing retirement income with less reliance on their savings,” he says.