JPMorgan Hits the Mark in Target-Date Funds
Morningstar's Allocation Fund Manager of the Year stands out with its attention to investor behavior, greater diversification, and tactical tilts.
Leo Acheson: Hi, I'm Leo Acheson, manager research analyst here at Morningstar, and I have with me Anne Lester and Dan Oldroyd, portfolio managers of the JPMorgan SmartRetirement target-date funds. Anne and Dan and the rest of the team are also winners of Morningstar's 2014 Allocation Fund Manager of the Year award.
So, guys, thank you for being here and congratulations on the award.
Anne Lester: Thank you so very much. We are thrilled to be here and very honored by this.
Dan Oldroyd: It's a pleasure. Thank you.
Acheson: So, as I had referred to, you two take the lead on the SmartRetirement funds, but you work with a broader team. Could you briefly describe the rest of your team that also won the award?
Lester: Sure. In our team, we have a collection of folks that represent all kinds of different functions, whether it is fundamental macro research, quantitative analysis and research, portfolio construction, portfolio implementation, manager selection, and due diligence. So, basically, we have representatives from the entire team collaborating together to deliver the solution. The five main portfolio managers on the strategy who also include Jeff Geller, our CIO, Mike Schoenhaut, and Eric Bernbaum, all of us collectively think about the big decisions. And really, Mike and Eric are implementing on a day-to-day basis our tactical views and making sure every single idea that the broader team has gets into the portfolios.
Acheson: So, the SmartRetirement funds had a great year in 2014. When you look at target-date funds, there are a lot of different moving pieces; but if I take a step back and look at your series, I would say there are three main areas where it can differentiate from peers and/or the benchmark, including your strategic asset allocation or glide path design, your manager selection and your tactical decisions. Would you say that's fair?
Oldroyd: Yeah, that's absolutely fair. The thing I also would add into that is the element of how risk is handled in each stage of the process and woven through the whole investment process.
Acheson: So, I guess if we took those one piece at a time and discussed how they contribute or drove some performance during the year, could you maybe begin with a brief description of how you set your glide path and asset allocation and how that differs from peers and how that performed during the year?
Lester: Sure. Well, when we think about the construction of the glide path, to us, the biggest decision to make is how much risk should you be taking for someone who is 20 or 25 and how much risk should you be taking for someone who is 65? And we spent a lot of time when we originally built the series--almost 10 years ago now--looking at the factors that contribute to the way people save and spend, and really thinking about integrating behavioral economics to make sure we're getting the right level of risk. And just as a snapshot of how we think about it, people like winning, and it feels really good when you make money. But, man, do people hate losing. And when you lose money or when you fall short, it actually hurts twice as much as winning makes you feel good. So, that was an integral insight into the way we thought about managing risk. And I'll let Dan walk you through in a little more detail how that rolls through different points of the glide path.
Oldroyd: So, in assembling the glide path, we are using our long-term capital market assumptions in conjunction with the behavioral elements that Anne just described. In terms of what the glide path looks like and some of the drivers in 2014, we own a very globally diversified portfolio in both equities and fixed income, including asset classes you typically see in an institutional investor's portfolios--bringing them to the individual-participant level. More specifically, we tend to hold a little less in equities than our peers, but we think about equities as one component of the return-seeking portion of the portfolio.
In 2014, we had, certainly, a position in U.S. large-cap equities that was very helpful. Positions in things like REITs were very helpful in 2014 as they rallied really strongly--as well as, in 2014, the core fixed income in the portfolios. And I know that's surprising to some people, but actually it was a strong performer for us. Those were all good positioning points for the strategic glide path, if you will, of the portfolios.
Acheson: I think, when I look at your series, that it tends to be a little bit more diversified than some of your peers, and so some of those dedicated allocations to specialty asset classes, such as REITs, performed well during the year.
Oldroyd: Absolutely. REITs were up close to the 30%. Really, what it comes down to is how efficient can we make this portfolio? How much risk do we have to spend to get units of return? And if we can be more efficient in constructing the portfolios, we think that that, compounded over the course of 40 or 50 years, is going to be a winning outcome for investors.
Lester: And actually, it'll be a winning outcome through different market environments. So, we saw strong results in '14, but we've seen them in other, very different kinds of environments as well. And to us, it's that thought of balancing risk and return and being very explicit and conscious about what kinds of risks we're trying to take in what kinds of market environments--both strategically and tactically as well.
Acheson: Can you speak about the performance of the underlying managers during the year?
Oldroyd: Sure. When we talk about who the team of the SmartRetirement portfolios is, it's the global multi-asset group, the solutions business, we have 100 investors working on that. And then we have access to all the investors at J.P. Morgan Asset Management and the JPMorgan fund series. So, we have access to investors in most markets around the world, and what we're looking for is what I would call "differentiation of the investment engine," looking at different types of managers in each asset class and trying to get a diversification, if you will, of style--whether that's someone who might be more quantitative in nature and using what I'd call "algorithmic techniques" to build portfolios or investment portfolio managers who are building their portfolios from a bottom-up basis. So, one of the main decision-making points around our manager due diligence is, what is the overall effect in putting them together in the portfolio? And in 2014, we had a lot of strong results from our underlying managers, particularly in our U.S. large-cap space as well as our small-cap space.
Acheson: So, in the U.S. large-cap space, some of those managers who did well, do you think they can continue to keep the pace going forward?
Oldroyd: We certainly hope so. But one of the things we do look for is the consistency of the manager and consistency in terms of their performance in multiple market conditions, performance versus their benchmarks. Peer rankings will move in and out of favor; I think everyone is aware of that. But if we can get a consistent manager who is going to give us exposure to a factor on a repeatable basis, that is something we like to incorporate into the portfolios.
Lester: It isn't necessarily that we think they will generate alpha in every market environment, because we know nobody will consistently do that. What's really important to us is to understand what are the drivers and, as Dan said, the factors that will lead to their alpha, and whether we see them consistently using that investment process in different cycles. And then as we have our own cycle-aware views, we actually can and have very successfully leaned in and out of some of those managers. And when we're trying to overweight an asset class, sometimes--not always but sometimes--specifically overweighting certain managers because we think their style is going to do better in a specific market environment and certainly, through the depths of the crisis, we were underweight our quantitative managers, and they really spent a little more time struggling than some of the more valuation-driven or fundamental managers did. And you should be looking to us to continue that kind of tilt to the extent to which we've got conviction that a specific environment is going to be upon us and that we think a manager will either excel or not versus their benchmark.
Acheson: Then your team also engages in tactical positioning, which is a differentiator versus some of your target-date peers. So, can you talk a little bit about what drives some of those tactical positions, what sort of leeway you have, and then also how those positions changed during the year, what contributed, what detracted?
Oldroyd: So, for tactical positioning, if we think about the pillars, there is the glide path, there are your managers, and then the tactical positioning would be short-term deviations from the glide path. Thinking about it, I mentioned 40- or 50-year horizons, glide paths are meant to be very long term in nature. And we are all aware that there are short-term market events, and we have been working into all of our portfolios the ability to take advantage of views on those short-term market events, in terms of adjusting the glide path a few percentage points here or a few percentage points there. Specifically, what we're looking at for those tactical positions and how we generate those is the work of our qualitative research team--people looking at macroeconomic fundamentals in addition to some quantitative models that we're running that suggest positions. So, for example, in 2014, both of those teams lined up with the view that U.S. large-cap equity was a place that was going to be most favorable if we look across asset classes--when we look across regions. So, we're, for most of the year, overweight U.S. large-cap equity by anywhere between 3% and 5%.
Acheson: How about in the fixed-income space? Were there any notable positions there? And then how would you position going forward?
Lester: Dan will let me take that one. So, fixed income was a tough call last year. We and many other managers entered the year thinking interest rates were going to be on a one-way trip up. And we very rapidly revised that view from "Hmm, maybe they're not going up as fast as we thought" to "Hmm, maybe they are going to keep going down." So, we actually started the year with a position that was underweight duration and very quickly, at the end of the first quarter and beginning of the second quarter, moved to a neutral position. And actually, we've ended up at the year a little bit long duration, which is a very counterintuitive position when we all believed that the central bank is going to start raising interest rates. One of the benefits of a multi-asset asset-allocation process is that it lets us take, on the one hand, this high conviction in U.S. growth and overweight to risk assets in general in U.S. equities in particular and say, "Great, we believe that's true."
We also believe that interest rates are going to be under fundamental long-term pressure from this lower-for-longer environment around the world. And even if our Fed starts raising rates this year and pushes up rates on the shorter end of the curve--sort of between zero and five years--we think the longer end of the curve is going to continue to stay relatively low because of where the Japanese and the Germans and Europeans have their yields. So, there is a carry trade. People are buying U.S. Treasuries and selling bunds and [Japanese government bonds] in Germany and Japan.
So, we're able to take our view and say we love risk assets. But just in case, one way of allowing ourselves, if you will, to take a little more risk on the equity side is actually to buy fixed income--which is, in many environments, a great hedge against that equity risk. So, in a way, we're putting a fixed-income view on that says the curve is going to flatten, and we are also managing total portfolio volatility and total portfolio risk by doing something that's fundamentally defensive in nature, but explicitly coupling that with a very much risk-on bet. So, it lets us, as Dan said earlier, take risk where we think we're going to be compensated for it and take it in the right way for people who are using this as a long-term savings vehicle.
Acheson: So, not all of your tactical decisions contributed during the year; but on a whole, your tactical allocation and positioning contributed during the year?
Oldroyd: Yes, it did. Historically, the process and the tactical positioning have added 50 basis points or so of returns in the portfolios. In some markets, it's gotten us defensive--in say 2008, we were short in risk assets. And in other markets, it's gotten us offensive. So, it's been a combination of both the additional alpha generated but also the reduction in volatility in certain markets.
One of the things I think it really does contribute to is it allows us to avoid systematically buying into an asset class. And especially with something like target-date funds, where you're essentially moving from equities into fixed income, that allows us to think about specifically what types of risks we want to take on. So, yes, the portfolios might become more conservative by nature of the glide path, but what we're able to do is in some instances keep duration short, or in some instances have a little bit more equity in the portfolio. So, I think it's a more intelligent way to think about long-term investing for individual investors.
Acheson: Great. Anne and Dan, thank you so much for your time. We really appreciate you being here.
Lester: Well, thank you very much.
Oldroyd: Thank you very much.