Topic Paper

June 2017

Glide Path Optimization Avoids

Slippery Slope of Extended Equity Risk
WHY WE BELIEVE A “TO” GLIDE PATH OFFERS THE BETTER SOLUTION

SUMMARY
Seven years after the credit crisis, with equity markets
having reached new highs, how much equity risk is
appropriate in the final years leading to retirement? In this
paper we will:
1. Remind readers of the economic landscape that
provided fuel for the debate
2. Discuss the current target date fund environment
3. Show the importance of a glide path Stephen Lingard, Michael Greenberg,
MBA, CFA CFA, CAIA
4. Make the case for a “to” glide path approach
Senior Vice President Vice President
5. Discuss the optimization of a glide path and how it was Franklin Templeton Multi-Asset Franklin Templeton Multi-Asset
developed for the Franklin LifeSmart Portfolios Solutions Solutions

Retirement Plans Knocked Off Track by the Great Canadians Also Experience a Toll on Retirement Confidence
Recession In Canada, according to the 2008 Benefits Canada survey of
CAP Members, the average respondent expected to retire at age
The bear market that resulted from the piercing of the technology
59.4 with assets of $1.3 million.2 In the intervening years, the
bubble in 2000 was only a prelude to the stock market declines
average expected retirement age has been increasing and the
suffered during the 2008 financial crisis. Together, they rendered
amount of expected assets has been decreasing. By the 2014
the 2000s a lost decade for equity investors and disrupted the
edition of that survey, the average respondent expected to retire
plans of many new and near retirees. Those who had already
at age 63.3 with $709,000 in assets.3
entered a drawdown scenario by 2008 found themselves facing
harsh choices, as market assumptions built into asset allocation The 2008 CAP Member survey also showed that 71% of
plans did not live up to expectations, and retirement portfolios respondents were either “very” or somewhat confident of having
were put under severe stress. enough money to live comfortably through retirement. By 2014,
despite experiencing a stock market that more than doubled in the
The uncertain financial footing clearly contributed to investor
six years since bottoming out, only 50% feel financially prepared
perceptions about retirement. According to the 24th annual
for retirement.
Retirement Confidence Survey—conducted by the Employee
Benefit Research Institute (EBRI)—Americans’ confidence in their Clearly, perceived financial security has taken a blow. And as the
ability to afford a comfortable retirement has recovered somewhat era of defined benefit plans fades into employee funded (and
from the record lows of the past five years. Eighteen percent are directed) defined contribution plans, pre-retirees are bearing the
now very confident (up from 13% in 2013), while 37% are additional burden of knowing they are now responsible for their
somewhat confident. Twenty-four percent are not at all confident investment decisions.
(statistically unchanged from 28% in 2013)1.
1 Source: [Link] 2014 Retirement Confidence Survey, March 2014
2 Source: Benefits Canada Survey of CAP Members, November 2008
3 Source: Benefits Canada Survey of CAP Members, November 2014
For Institutional Use Only. Not For Public Distribution.
Target-Date Funds Arrive in Canada Today, DC plans form the backbone of many members’ retirement
After a decade of success in the US, Target Date Funds (TDFs) plans, and the growth of TDFs has accented the need for
came onto the Canadian scene in 2004 as a “a one-stop vigilance to ensure these investments perform in line with investor
diversified investment product” designed to make investing for expectations. The severity of the 2008–2009 bear market
retirement less complicated for capital accumulation plan provided a wakeup call to the industry, so it is imperative that plan
sponsors and their plan members. sponsors understand the three key differences among the target
date fund options available.
TDFs use a multi-asset approach that adjusts the asset mix
according to the plan member’s investment time horizon to 1 | Underlying funds – Variations include active or passive
retirement. The key difference is that the fund dynamically adjusts management (or sometimes both), value and growth investing
the asset mix over time—without any action from the member— biases, and market capitalization tilts.
with exposure to equity assets diminishing as retirement
2 | Asset mix – The combination of asset classes and the
approaches.
constraints will have a big impact on the return—and volatility—as
Given the well documented behavioural characteristics of many exposure to equities in bull markets can drive ultimate returns, but
CAP members (lack of investment knowledge and apathy towards in bear markets can prove highly volatile.
investment decisions), plan sponsors have welcomed TDFs into
3 | Glide path – The glide path—a TDF’s asset allocation track,
their plans as a responsible choice.
through time—is the most important element of the TDF, as it
A Rocky Start indicates how the asset mix will change over time. How that mix
The timing of TDF entry into the Canadian market has been changes over the member’s lifetime should be a significant focus
described as a “perfect storm” launching just before 2008 and for plan sponsors.
experienced significant volatility and much lower interest rates.
After the first few years, many were closed or forced to shift their Glide Path Structure
asset allocation to fixed income4. With an inglorious start, many While conventional wisdom dictates that asset mix is a key driver
analysts and journalists questioned whether these target date of successful investment outcomes, TDF providers do not readily
funds perhaps oversimplified the investment decision. agree on an appropriate asset mix for a given age. This can be
illustrated by looking at the range of equity allocations of the funds
The initial waters have smoothed over and new players have
at opposite along the target date spectrum especially those in
entered the market. Toronto-based Investor Economics estimates
their final accumulation years before retirement.
the category hit $12.8 Billion by the end of 2013. Over the most
recent three years, total net flows into TDFs amounted to $6.8 Funds designed for the younger cohort of plan members (30+
Billion of which 19% of net flows was allocated to funds maturing years to retirement) show a range of exposures to equity and
in 2025, 17% to 2020 and 2030 each, and 9% to 2045 or 2050.5 retirement TDFs can have an equity weighting as low as 25% and
Target Date Fund Asset Growth in Canada5 as high as 40%.
$ Billions
Equity Allocation of Popular Canadian Target Date Funds6
$14
Franklin
$12 Target Date LifeSmart Complex B Complex C Complex D
2050 84% 98% 84% 83%
$10
2040 81% 85% 81% 80%
$8
$Billions

2030 73% 71% 65% 72%

$6 2020 53% 54% 47% 48%

Retirement 33% 40% 30% 35%
$4
The table above shows points out the difference in philosophy
$2
about what providers feel is an appropriate asset mix at a single
$0 point in time, but glide paths also encompass the asset mix
2007 2008 2009 2010 2011 2012 2013 though time.

4 Source: “Target Date Funds Miss Their Mark”; Globe and Mail Tuesday,
August 25, 2009
5 Source: “Investor Economics, 2014 Group Retirement and Savings Report
Pre-release
6 Source: Franklin Templeton, July 1, 2015
For Institutional Use Only. Not For Public Distribution.
Glide Path Optimization Avoids Slippery Slope of Extended Equity Risk 2
Critical Importance of the Glide Path The Case for a “To” Approach
There are five key reasons that lead us to conclude that to is the
While the goal of a target date fund does not typically change—for
better approach:
example, most fund families have a consistent objective across all
target maturities—it is somewhat unique in that the fund allocation 1 | Investor life changes and peace of mind. Retirement can be
shifts over time to reflect the changing investor profile—namely one of the most stressful events in a person’s life. Shifting from
age/proximity to retirement. As a result, it is important to accumulation to distribution and no longer having employment-
understand how the fund intends to be allocated at any point in based income arriving on a regular basis can take an emotional
time as it moves toward (and past) the target date. toll, which is only exacerbated by market volatility at or near the
point of retirement. Earlier in the retirement planning process, “Will
The development and management of the glide path may be the
I save enough?” is the biggest concern. At or near the point of
central challenge for the target-date fund manager. How can the
retirement, the number one question is more likely, “Is the money I
portfolio be optimized to maximize its potential value by the target
have saved, ‘safe’?” A portfolio with less equity risk may well
date and provide sufficient growth during the drawdown phase to
deliver fewer investor worries. Virtually all investors were stressed
maximize longevity, while at the same time mitigating the potential
by the market decline in 2008 and 2009, but those worries were
disruption of a 2008-like event at, near, or during retirement when
amplified for near-retirees.
drawdowns will reduce the ability of the portfolio to recover and
investor options for replenishing the account may be limited? 2 | Portfolio recovery hampered during drawdown. There is
good reason for investors to be concerned with market volatility at
or around the retirement juncture. Drawing down from a portfolio
The Franklin LifeSmart Approach
that has suffered losses early in retirement can have a substantial
Because the performance of this class of funds has such impact on the portfolio’s longevity.
important implications, Franklin Templeton undertook an
exhaustive glide path analysis for the Franklin LifeSmart 3 | Expectations. “Retirement Target Date” should have meaning.
Portfolios. The stock market downturn in 2008 clearly shocked many
investors who participated in 2010 target date funds. With few
We wanted to make sure that the glide path: exceptions, the group suffered losses of more than 10% to 15%7,
just two years before the anticipated retirement date. In financial
1 | Reflects portfolio risk commensurate with the time to
terms, retirement has a basic meaning—no more income from
retirement.
employment. For many, the target date on their fund represents a
2 | Can help the portfolio weather a 2008-like market event better clear, tangible event. It is understandable why so many investors
than a traditional 60/40 allocation. were taken aback by the performance their funds achieved. We
believe the date in target-date should have relevance, especially
3 | Provides growth via equity exposure throughout the glide path, when investor behaviour seems to support the fact that they have
but keeps a high exposure to equity securities during earlier a distinct view on its meaning.
years.
4 | Investor behaviour. Studies have shown that investor
To Begin With—Where Is the End? behaviour is not consistent with the view that investors intend to
In glide path development, the question of where the landing maintain their investment long after reaching retirement. The
point—the final, most conservative allocation—should occur is Benefits Canada 2014 CAP Member Survey shows that while
fundamental. members agree that their total retirement income will come from
several sources, including personal RRSPs (17.3%), personal
Funds using a “through” approach appear to believe that the
savings (10.2%) and government pension plans (20.6%), they
product is a lifetime investment. Assets are managed as though
expect the biggest proportion (27.9%) to come from their
the individual will hold the investment well beyond the target date.
employer-sponsored retirement savings plan8. Converting the
This camp maintains a higher equity position at target date, only
TDF to a retirement-income-generating source at or near the date
reaching the final landing point some years later.
of retirement would imply that the asset allocation should be able
Advocates of a “to” approach have a fundamentally different view. to generate sufficient income without the potential volatility of
They believe that given all the potential changes occurring around equity risk.
retirement, the landing point should be reached at the target date.
7 Source: © 2015 Morningstar, Inc., 3/31/2015. All Rights Reserved. The
While there may be reasons to hold a higher equity position at this information contained herein: (1) is proprietary to Morningstar and/or its
point, it shouldn’t be the default. Rather, it is an appropriate time content providers; (2) may not be copied or distributed; and (3) is not
for investors to work closely with their financial advisors to warranted to be accurate, complete or timely. Neither Morningstar nor its
confidently enter this new life stage. content providers are responsible for any damages or losses arising from any
use of this information. Past performance is no guarantee of future results.
8 Source: Benefits Canada Survey of CAP Members, November 2014
For Institutional Use Only. Not For Public Distribution.
Glide Path Optimization Avoids Slippery Slope of Extended Equity Risk 3
While the goals of investing pre-retirement are relatively clear, Potential Glide Paths for a 100% to 0% Equity Reallocation
individual plans and circumstances—including longevity
expectations, spending, and retirement plans— vary greatly once
retirement is reached. Trying to provide a post-retirement glide
path is somewhat presumptive or speculative.

5 | “Fat tails” and other “non-normal” results. Models are built

on assumptions; they break down when those assumptions don’t
hold true. Many asset allocation models assume a “normal
distribution” of returns, which predicts that the likelihood of a
three-standard deviation event would happen three times in a
thousand. However, extremely negative results have occurred
more often than a normal distribution would imply—in other
words, a distribution pattern with a fat left tail. We incorporated
such factors into our testing. The results reinforced our conclusion
Input Assumptions
that a glide path whose most conservative allocation occurs at the
In order to test, we had to develop input assumptions. Our testing
target date is the optimal choice.
assumptions were based on data from the Statistics Canada and
Fat Tails other publicly available research and analysis on retirement age,
life expectancy, compensation, wage growth rates, inflation, and
post-retirement withdrawal rates, as well as historical asset class
returns from which we developed our proprietary capital market
expectations.

The following is a summary of the inputs we used in our base

case scenario.

Input Base Case

Inflation Rate 2%
Income Growth Rate 3%
Contribution Level % of Salary 5%
Withdrawal Rate % of Inflation-Adjusted Ending Salary 40%
Constructing an Optimal Glide Path Initial Contribution Age 25
Choosing the landing point was just the beginning. It was based Initial Withdrawal Age 65
on philosophical views and subsequently confirmed by deep, Capital Market Expectations Proprietary

rigorous analysis. But determining the starting and ending

allocations to equities and fixed income, and the appropriate Risk Factors Considered in Glide Path Development
transition over time, required months of testing and refinement of In assessing the success of any glide path, three competing risks
models. need to be weighed and balanced. They are:

We tested a broad range of initial and ending equity and fixed 1 | Interim risk: The investment, in striving for higher returns,
income allocations. But there are innumerable, paths to get from experiences excessive portfolio risk.
the higher initial equity allocation to the lower ending equity
allocation. We tested a linear approach as well as numerous 2 | Retirement income shortfall risk: The investment does not
convex and concave decay patterns. With concave decay, the appreciate enough so that at retirement, the portfolio value is
portfolio after its first year would have its most substantive shift insufficient to reasonably support a withdrawal strategy for the
from the original allocation and then more gradually glide into its anticipated annual income needs.
final allocation. With convex decay, the original allocation will
3 | Longevity risk: Despite having a portfolio value at retirement
slowly shift from its allocation at the start and then more rapidly
that is sufficient to meet anticipated needs, in retirement the
adjust nearer to the end date. In all, more than 10,000 different
portfolio fails to generate expected returns or the retiree outlives
potential glide paths were tested and millions of simulations run.
expectations.

For Institutional Use Only. Not For Public Distribution.

Glide Path Optimization Avoids Slippery Slope of Extended Equity Risk 4
A successful glide path could be expected to achieve the following Through differential evolution, suboptimal paths were discarded.
results: high portfolio value at retirement; high likelihood of the The iterative process and the optimization of results in light of the
portfolio having value remaining at age 85; and low risk of sharp risk parameters led us to what we believe is an optimal glide path.
portfolio declines in any given year, especially right before
retirement.

We determined a set of risk aversion factors that would be used in

the measurement of these risks upon our results. These included
median value at retirement and lowest 2.5 percentile value at
retirement, each of which was used to evaluate retirement income
shortfall risk. Probability of positive assets at age 85 was used to
assess longevity risk. And 1-year value at risk (VaR 95) was
assessed at both age 25 and age 65 to address the
consequences of market shocks on portfolio results (and investor
psyches).

Franklin LifeSmart Portfolios Glide Path

At Retirement Target Date, the approximate asset allocation for

the Moderate glide path will be:

LifeSmart Glide Path Characteristics

Equity Funds.........................................................34% 1. The lowest equity allocation begins at the retirement target date

Fixed Income Funds ............................................66% 2. A final allocation of 34% equity and 66% fixed income for the
LifeSmart Moderate glide path

3. Equity percentage exposure allocation decreases more quickly

as target date approaches

4. A favourable balance in addressing competing risk constraints

5. A tactical component to allow for adjustments during market

dislocations such as in 2008

For Institutional Use Only. Not For Public Distribution.

Glide Path Optimization Avoids Slippery Slope of Extended Equity Risk 5
 Reduced Impact of Market Disruptions End of Glide Path Assumes:
Despite the ongoing shift toward a higher fixed income allocation
throughout the glide path, the modeled equity value continues to Actual Canadian Canadian
Years to Retirement Year Equity Bonds
increase until five years before the target date.
4 2008 -33.00% 6.42%
Accounting for extreme market events was an important 3 2009 35.05% 5.41%
consideration in the development of our LifeSmart glide path. As 2 2010 17.61% 6.74%
illustrated below, the impact of market declines as experienced in
1 2011 -8.71% 9.67%
2008 can be somewhat mitigated with the path developed.
0 2012 7.19% 3.60%
Although occurring at peak equity values, the portfolio still had
Canadian Equity is represented by the S&PTSX Index. Canadian Bonds are represented by the
time to recover to a near normal path. FTSE TMX Canada Universe Index

Hypothetical LifeSmart Model Glide Path Equity Value vs. Hypothetical

Based on 2008-2012 Market Returns from Years 4 to 0 A Final Note on Diversification and Franklin Templeton
Under normal market conditions, the Franklin LifeSmart Portfolios’
investment manager allocates each fund’s assets among the
broad asset classes of equity and fixed income investments by
investing primarily in a distinctly-weighted combination of
Equity Value

underlying funds, based on each underlying fund’s predominant

asset class. A small portion of each fund’s assets may be
invested in exchange traded funds (ETFs). In addition, a small
portion of the fund’s assets may be invested in underlying funds
that provide exposure to commodities. The underlying funds and
ETFs invest in a variety of U.S. and foreign equity and fixed
40 35 30 25 20 15 10 5 0
Years to Retirement income securities.
Ending Equity $ Value 2008
In recent years, alternative asset classes have also started to gain
Ending Equity $ Value Normal traction within TDFs. Commercial real estate, commodities,
The rapid lowering of equity exposure in approaching the landing private equity and mortgages are typical examples of alternative
point helps to reduce the impact of such events. assets—all of which offer diversification benefits such as lower
correlations to traditional asset classes. At present, some TDFs
Reallocation helped to ensure appropriate exposure as equity
provide exposure to alternative assets through listed products
markets recovered.
(e.g., real estate investment trusts and listed infrastructure, which
Impact of 2008-2012 Market Returns on Hypothetical LifeSmart Model Glide are traded on a stock exchange). But these listed products, while
Path Portfolio Value if Occurring from Years 4 to 0 they do improve asset mix characteristics, do not fully capture the
benefits of alternative assets due to their equity-like volatility.
Going forward, the asset mix component of TDF design will likely
Portfolio Value

evolve through the use of alternative assets, particularly direct

alternatives (i.e., those not listed on an exchange).

40 35 30 25 20 15 10 5 0
Years to Retirement

Ending Port Value Ending Port Value Normal

Note: The return assumptions used for this chart are equity returns
of 8% and fixed income returns of 3% percent, and an annual
contribution that increases each year by 2%. (assumed rate of
inflation). It does not reflect the actual portfolio composition of the
Franklin LifeSmart Portfolios or their historical results.

For Institutional Use Only. Not For Public Distribution.

Glide Path Optimization Avoids Slippery Slope of Extended Equity Risk 6
Risk Tolerance About Franklin Templeton Multi-Asset Solutions
One knock against many target date fund families is that they do FT Multi-Asset Solutions9 is a group of multi-asset experts
not account for an investor’s risk profile when determining the focused on creating total portfolio solutions integrated with risk
management, to help investors achieve their financial goals
appropriate asset mix. They assume all members in the same
regardless of market conditions. The team has specialists in
age class should hold the same investment mix. Some more long-only strategic strategies, alternative strategies and tactical
recent funds—including LifeSmart—offer the ability to choose a allocation strategies. With over 80 specialists, FT Multi-Asset
fund that not only matches the member’s time horizon, but Solutions manages over $40 billion in total portfolio solutions
incorporates the individual’s conservative, moderate or growth- diversified across traditional and alternative asset classes and
an additional $50 billion in advisory assets. The team is
oriented risk tolerance.
embedded within Franklin Templeton Investments, a global
organization combining access to the local insights and global
This can be an attractive concept, given that risk tolerance is
perspective of over 650 investment professionals.
dependent on factors other than age.

We believe diversification is more than equity and fixed income

allocations, however, and Franklin Templeton offers the strength
of a diverse set of portfolio management teams possessing
distinct philosophies and investment styles. From that wide
opportunity set of products, we have the ability to construct well-
diversified portfolios that can meet the needs of investors
seeking target-date fund solutions.

9. FT Multi-Asset Solutions is a world-wide team dedicated to

global portfolio-based solutions, which draws on the expertise of
a number of Franklin Templeton affiliates. In Canada, the
advisor to the FT Multi-Asset Solutions mandates is Fiduciary
Trust Company of Canada a wholly owned subsidiary of Franklin
Templeton Investments Corp.
Franklin LifeSmart Portfolios are offered through insurance company and financial institution group savings platforms and can not be offered or sold directly.
Franklin LifeSmartTM is a trademark owned by Franklin Templeton Investments Corp. CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.

Franklin Templeton Investments Corp.

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Toronto, ON M5H 3T4
Tel: (416) 957-6000
Fax: (416) 364-1320
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