The Performance Trap and the Challenge of Immunization

Should DC asset allocation programs (e.g., target-date funds, managed accounts) be all about maximizing performance, or should the focus be on increasing the certainty (and protection) of a steady stream of income in retirement? This is the thin line that DC asset allocators must walk.


Today, there are two distinct strategies behind individual DC portfolio design:

  • Maximize total wealth while maintaining an acceptable level of diversification, so as to minimize the impact of market volatility
  • Maximize hitting a retirement income goal, while immunizing future income streams against the fluctuating cost of retirement income

Both approaches assume that market performance will be cyclical over time as the markets expand and contract in response to the economy’s recession/expansion cycles. Where these approaches differ is in their view of how the DC investor should be positioned when they arrive at their retirement date.

Most of the popular target-date funds that are focused on maximizing wealth ratchet down the equity exposure over time and, by the retirement date, have approximately 40% of the portfolio invested in equities with the balance in fixed income investments. This 40/60 mix often remains the recommended mix throughout retirement.

It could be argued that the wealth accumulation approach works just fine if the market behaves like it has since the Great Depression ended in 1939: expansion followed by a recession which, in turn, is followed by another expansion and so on. However, what happens when the market goes down and stays down for an extended period of time? A case in point is Japan, which saw its’ markets plunge in value in late 1991 and early 1992. To this day, Japan has never fully recovered from that market downturn. In fact, the Japanese stock market’s 20-year high is only half its 1980s peak. So much for the pattern of expansion/recession/expansion!

Could the U.S. markets (and other developed countries) experience the same type of market implosion as Japan’s and stay down for an extended period of time? James Bullard, the President of the Federal Reserve Bank of St. Louis, argued in a paper written shortly after the Great Recession, that “the United States is closer to a Japanese-style outcome today than at any time in recent history.” (“Seven Faces of ‘The Peril,’Federal Reserve Bank of St. Louis Review, September/October 2010)

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Predictions such as this are largely based on the assumption that the U.S. and other developed countries’ stock markets could find themselves in the same “liquidity trap” that Japan did in the early ’90s — a situation in which nominal interest rates cannot be sufficiently lowered to stimulate the economy because they are already close to zero. It is not hard to imagine that, given the Fed’s loose monetary policy and where rates are today, the U.S. market could very well suffer the same fate as Japan. Would DC investors near or at retirement be in the position to “wait it out” if the U.S. stock market tanks in a fashion similar to the Japanese scenario?

The Performance Trap

The challenge faced by many asset allocation providers is that the market tends to focus on performance rather than on portfolio design. There are several reasons for this:

  • Asset allocators overwhelmingly deploy their strategies via a suite of target-date funds
  • In general, “funds” are focused on performance (e.g., 3, 5 and 10 years) versus income protection
  • Investment performance is a relatively straightforward metric that fits nicely in an Investment Policy Statement (IPS) and in Investment Committee discussions
  • Portfolios that are designed to focus on and immunize future income streams may or may not look good in terms of their relative performance versus a fund focused on achieving the highest level of (mostly recent) return in a diversified portfolio.

Immunizing Future Streams of Retirement Income

The focus of an immunization strategy is to optimize the positioning of investments on the date the DC investor retires. The following are two methods of immunization in use today:

  • Starting at some period before retirement (e.g., 20 years), an increasing amount of the investors assets are shifted from “risky” assets to — as is the case of the Dimensional Fund Advisors Target Date Income Funds (TDIF) — a TIPs portfolio that is focused less on growing income and more on managing income risks. At the retirement date, an investor in a DFA TDIF should expect to have approximately 80% in an inflation-protected bond portfolio that is designed to support 25 years of retirement income.
  • Another approach (currently being utilized by BlackRock via their CoRI Retirement Indices and deployed through their iRetire planning software) is to create a duration-matched bond portfolio that is tied to the estimated future cost (annuity price) of retirement income. “The CoRI Indexes are bond funds,” researcher Wade Pfau wrote in 2015. “But they are not just any old bond funds. Rather, they are bond funds whose prices are calibrated to move in lock-step with the price of an income annuity with a 2.5% COLA which will begin income at age 65.” (“CoRI Index: A Tool to Lock-in Annuity Prices without Annuitizing,” Retirement Researcher, Wade Pfau, March 25, 2015)


Given that immunization strategies are not focused on achieving the highest performance numbers each and every year, they do not fit neatly into the “traditional” Investment Policy Statement. However, immunization strategies can make a difference, especially if the rest of the developed world has a Japan-like market experience at some point in the future. Nonetheless, as long as plan sponsors and advisors focus on superior “fund performance” versus advanced “portfolio design,” the transition to an emphasis on creating — and most importantly, protecting — retirement income will be a difficult one.

Jerry Bramlett is the head of Ascensus’ TPA Solutions division. Before joining Ascensus in April 2018, he was Managing Partner at Redstar Advisors and Managing Director at Sage Advisory Services. This column appears in the Summer issue of NAPA Net the Magazine.

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