Ensuring a glide path’s asset allocation is correct is really important since it’s going to be managing the bulk of positions for so many defined contribution plan members, according to Ruthann Pritchard, speaking at the 2018 Defined Contribution Investment Forum in Toronto in September.

While the level of equity within the glide path at any given moment is considered a top-of-mind risk, there’s more at play, according to Pritchard, institutional portfolio manager at Fidelity Investments. “We know there are other risks out there. Equities? Yes, they bring risk to a portfolio. But there are other risks that are hiding, waiting in the glide path and we ant to know what they are,” she said.

Glide paths are sometimes constructed using historical averages, she noted. “If you look at the history of Canadian financial markets, Canadian equities have returned about 5.3 per cent over the life of the Canadian markets. Canadian investment grade [bonds] have returned about 4.9 per cent and then short-term investments about 2.4 per cent.”

Read: Boosting the glide path to optimize target-date funds

It’s entirely possible to create a strategic asset allocation based on those data points, said Pritchard. However, volatility within those assets shows there are many times when basing an allocation on those averages would create sub-par performance, she added. “This portfolio would perform beautifully in certain environments and terribly in others, and every basis point that you lose because you don’t have an efficient portfolio at the bottom of your glide path is not just excess return, it’s income. It’s retirement outcomes for members.”

Over the history of Canadian markets, three distinct environments have emerged: an expansionary period, a contractionary state and recovery, said Pritchard. “The trouble is, it is totally impossible to know when one of these market environments will be happening in reality.” Having an optimized portfolio means something different in each of these states, she noted, so there’s risk in being prepared to deal with long-term averages, but the market is actually in an expansion phase, for example.

Read: Divergence could indicate volatility on the horizon

Creating a neutral portfolio that functions no matter which phase the market is in is the first step to forming a strong foundation underpinning the glide path, said Pritchard. Adding to this, the natural forward-looking considerations of a target-date fund are different depending on a number of variables, including the member’s age, income level and retirement date. For instance, depending on the member’s age, the cushioning neutral portfolio would be larger or smaller. And a 25-year-old member’s assets would be far less allocated to this neutral component than the assets of a 55-year-old, she noted.

Read more stories from the DC Investment Forum