Data & Research October 17, 2012

J.P. Morgan Recommends Factor Risk Parity

Risk parity is an alternative form of portfolio management that allocates capital based on the underlying risk of asset classes, rather than anticipated returns.
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In a research paper, J.P. Morgan Asset Management contends that traditional risk parity has significant drawbacks and recommends an asset allocation model based on factor risk parity.   

According to “Diversification: Still the Only Free Lunch?”, the biggest problem with traditional risk parity is its high exposure to leveraged fixed-income assets at what looks like an increasingly vulnerable point in the interest rate cycle.  Another weakness is that it presumes different asset classes are uncorrelated or have low correlations. In reality, seemingly diverse asset classes can have unexpectedly high correlations because they share common underlying risk factor exposures.   

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The paper says many institutional investors and consultants have done work on using risk factors as a basis for portfolio diversification. The idea is that asset classes can be broken down into building blocks, or factors, which explain the majority of their risk and return characteristics. A factor-based investment approach enables the investor to theo­retically remix the factors into portfolios that are better diversified and more efficient than traditional methods.   

However, the paper warns that building and implementing factor-based portfolios from scratch can be challenging and largely impractical for institutional investors, often because they require things like frequent rebalancing and the nimble use of long/short positions to fully optimize the portfolio.   

More information about improving on risk parity can be found at www.jpmorgan.com/institutional.

Data & Research October 17, 2012

Retirement Picture Rosier for Health Care Workers

Despite being younger than others, on average, workers at tax-exempt health care organizations have saved more for retirement ($50,000 vs. $33,000).
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According to Fidelity’s Retirement Savings Assessment research, while health care workers do have somewhat higher average salaries, the increased savings seem to be due to a savings rate twice the average of all workers. In addition, their savings are invested with a slightly higher allocation to equity.  

Fidelity’s Retirement Savings Assessment uses proprietary methodology to estimate the potential percentage drop from preretirement income that the typical working American household is expected to experience upon retirement. Fidelity’s 2012 assessment found that working households with health care workers are estimated to experience a potential income drop of 22% in retirement versus 28% for the general population (see “Americans May Experience Income Drop in Retirement”).  

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Fidelity found 43% of health care workers have retirement savings in a not-for-profit defined contribution (DC) plan, 18% in a for-profit DC plan, 14% in a taxable account, 11% in a traditional IRA, 8% in a Roth IRA or 401(k) and 5% in an annuity.   

The average allocation of savings for health care workers is 55% equities and 45% bonds or cash, compared to a slightly more conservative 48% equities and 52% bonds for all working Americans. Ten percent have all of their savings in cash or bonds (vs. 23%), and 13% are invested entirely in equities (vs. 18%). Eleven percent of health care workers are invested solely in lifecycle funds—similar to the 10% for all working Americans. 

In addition, more health care workers (40%) expect to enjoy a health plan provided by a previous employer in retirement than do the general population of workers (33%). For 46% of them, the health benefit will cover both the individual and their spouse. For the remainder, just one individual will be covered. 

Fidelity’s Retirement Savings Assessment research found 83% of health care workers expect to receive Social Security retirement benefits, and the median expected monthly amount is $1,200—the same amount as for the general population. Fifty-three percent expect to begin receiving benefits by age 65, including 13% who plan to take their benefit at the earliest eligible age (age 62).  

The top reasons for taking benefits at age 62 are: 

  • 26% because that is the age at which they plan to retire; 
  • 26% are concerned that future benefits will be limited or reduced; 
  • 13% are concerned about their health or longevity and want to start receiving income immediately; and 
  • 9% need the money as soon as possible. 

Only 10% expect to wait until age 70 to begin receiving benefits, and 13% have yet to decide.  

Social Security is expected to comprise more than one-third of total income for 32% of households with health care workers versus 36% for the general population. In addition, 47% of health care workers expect to work at least part time in retirement. The anticipated median monthly income from this work is $1,000. Seventy-four percent expect to receive or are already receiving a pension, with estimated median monthly income of $1,200.  

Despite their rosier retirement outlook compared with the general population, more than half of health care workers (54%) do not agree they have a well-developed financial plan. On the other hand, close to two-thirds feel they do have the time needed to monitor their investments (63%) and believe they have a handle on the fees they are paying for them (66%).  

Households with health care workers are more likely to work with paid financial professionals to plan or invest for retirement (26% vs. 19% for general population).

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