In target date funds (TDFs), fixed income assets play a critical role in managing portfolio volatility and generating strong risk-adjusted returns—a role that becomes even more vital as participants approach retirement. Plan sponsors may want to consider the following when evaluating a TDF's fixed income allocation:
• A well-diversified fixed income allocation may be able to deliver more consistent risk adjusted returns across a range of investment environments than a more narrowly diversified, concentrated allocation confined to those fixed income indices that can be efficiently replicated.
• Skilled active fixed income managers generally have greater flexibility and more tools than passive managers for generating strong risk-adjusted returns over time. Replicating a fixed income index can be more complex, costly and subject to structural bias, and involve more active decision-making, than some investors realize.
• Interest rates are widely expected to climb higher. Ensure that your TDF strategy can adapt to such changes and represents a reasonable compromise between controlling costs and providing participants with the potential for a smooth path to a financially secure retirement.
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