The fixed income allocations in our target date portfolios are designed to reflect the nuanced roles that the asset class plays within multi‑asset portfolios. These range from the goal of mitigating equity risk to seeking to preserve purchasing power against inflation. We have thoughtfully evolved our fixed income design over time as part of our efforts to improve outcomes for investors.

In 2017, after careful review, our target date portfolio team made a number of meaningful enhancements to the fixed income allocations in our target date strategies, changes designed to take advantage of a broader global fixed income opportunity set and better align those allocations with the changing needs of retirement investors as they move along their target date glide paths.¹ We have continued to adjust our allocations modestly in the years since, with an eye toward continuing to improve outcomes for investors. A relatively small allocation to a total return oriented Dynamic Credit Fund was added in August 2023.

A review of the performance of our fixed income allocations since the 2017 changes were fully implemented demonstrates that our efforts to enhance fixed income diversification yielded tangible benefits for investors who were at or past their target retirement dates —periods when fixed income is a meaningfully sized portion of the overall target date portfolio.² Our performance analysis illustrates that these enhancements delivered the diversification benefits expected by our target date team, confirming the rigor of our design process.

We found that the enhancements improved the overall performance of our target date strategies by enhancing fixed income returns on both an absolute and a risk‑adjusted basis at and after retirement, relative to T. Rowe Price’s previous strategic allocation design (Figure 1).

The evolution of our fixed income design

The growth of global fixed income markets in recent years has greatly expanded investment opportunities. A broader opportunity set has created additional opportunities for diversification and for skilled active management to generate excess returns.

"A broader opportunity set has created additional opportunities for diversification and for skilled active management to generate excess returns."

To take fuller advantage of these opportunities, our target date team decided that a number of allocation enhancements had the potential to dampen total portfolio volatility and improve risk‑adjusted returns. These enhancements affected two major categories in our target date fixed income portfolios:

• The core component, which consists primarily of investment‑grade bonds and a lower‑volatility foundation for the overall fixed income allocation. The core component represents 70% of the total fixed income portfolio³ across the entire glide path.
• A diversifying component that includes additional return‑seeking sectors, such as high yield bonds and emerging market (EM) debt. This component represents 30% of the fixed income allocation across the glide path, but the weights within it are dynamic, changing over time as the target date portfolios move along their glide paths (Figure 2).

Our 2017 design enhancements, and the thinking behind them, are summarized in Figure 3.

The Dynamic Credit allocation added to our glide path in 2023 is a differentiated strategy that can invest across all credit instruments to seek to take advantage of pricing dislocations and compelling yield opportunities wherever they manifest.

The benefits of an active approach⁴

In our view, the expansion of the global fixed income opportunity set has created additional opportunities for skilled active management to seek uncorrelated sources of excess return. Taking advantage of these opportunities is a key goal of our fixed income design.

The use of passive investment components can be challenging, especially in the fixed income arena. Within some fixed income sectors, it isn’t practical—or in some cases even possible—to hold all the securities in the most common market indexes, which could make difficult to replicate benchmark performance without potentially significant tracking error.

Replicating benchmark exposures also may result in unintended or undesired risk concentrations, which could result in higher risk of loss from potential defaults or downgrades in the largest issues. An active investing approach allows for credit research that we believe may help mitigate certain default risks.

Many of the fixed income diversification enhancements we have made to our target date design would be inefficient or impossible to replicate using only passive components. A purely passive approach also can foreclose potential opportunities to generate excess returns.

The addition of a nontraditional global bond fund in our core component, for example, was designed to supplement traditional fixed income qualities with a focus on downside risk management, providing diversification during periods of risk aversion. The fund manager also has the ability to use multiple active levers—such as duration⁵; yield curve positioning; and sector, country, and currency exposures—to seek excess return opportunities.

Likewise, the addition of a floating rate bank loan fund to the diversifying component—supplementing a portion of the high yield bond allocation—provides additional mitigation against duration risk and extends the potential benefits of T. Rowe Price’s credit research capabilities.

In addition, T. Rowe Price takes an active approach to managing allocations to the underlying building blocks in our target date strategies with dynamic tactical adjustments. We believe we can harness the insights of leaders in the firm’s equity, fixed income, and multi‑asset investment divisions by leaning into or away from asset classes based on our 6‑ to 18‑month market outlook. In our view, having a diversified set of underlying strategies gives us the ability to implement our views as markets evolve over the shorter term, which can support our investors over the long term as well.

Performance analysis

A review of our target date fixed income allocations verifies that our enhanced design improved returns for investors at or beyond the point of retirement. Although results were less robust than the prior design for portfolios at the earliest points on their glide paths, those typically are periods when investors have not yet accumulated significant wealth and are more concerned about the long-term growth drivers in their portfolios.

We looked at the performance of our enhanced fixed income design at different points along the glide path for our Retirement Funds—40 years before retirement, at retirement, and 30 years after retirement. We compared performance results since full implementation of the changes with the performance of the strategic allocations in our previous fixed income design. The results of our analysis are summarized in Figure 4.⁶

Relative to our previous fixed income design, performance improvements ranged from 0.46 percentage point (46 basis points) at age of retirement to 0.59 percentage point (59 basis points) at 30 years after retirement, annualized.

At retirement (age 65), for example, the enhanced fixed income design raised annualized returns by more than 0.46 percentage point (46 basis points), relative to our previous design.

Our enhancements also had the additional effect of reducing overall fixed income volatility as portfolios reached and passed their target retirement dates—a key benefit amid 2022’s bond bear market. This resulted in higher Sharpe ratios for the entire fixed income allocation at retirement and 30 years after retirement relative to the previous strategic allocation.

Not all fixed income is created equal

In addition to the components outlined above, our target date fixed income design also includes an allocation to short‑term TIPS. This allocation is designed to help offset the potential negative impact of inflation—especially an unexpected acceleration in inflation—on real portfolio values.

The TIPS allocation is dynamic and increases as portfolios move along their glide paths, both as a share of the total fixed income allocation and as a percent of the entire portfolio (Figure 5).

The shorter duration of our TIPS allocation made a meaningful contribution to relative performance during the 2022 bond bear market. While many target date fixed income models include a TIPS component, those allocations often are benchmarked to broad TIPS indexes that include longer‑term securities.

Reflecting their longer durations, many of these indexes experienced losses comparable to traditional core bond benchmarks in 2022.

The Bloomberg U.S. Government Inflation Linked 1‑10 Year Index, for example, posted a 7.38% loss in 2022. In contrast, the Bloomberg U.S. Treasury TIPS 1‑5 Year Index fell less than 4%, as its more limited duration helped cushion interest rate risk while still mitigating the erosive impact of inflation on real (inflation-adjusted) yields.

Strengths of T. Rowe Price’s target date design process

T. Rowe Price has been an industry leader in target date investing for nearly two decades. We constantly reassess our design to seek improved outcomes. Our fixed income portfolios reflect the depth of our asset allocation expertise and the rigor and discipline of our target date design process.

Our target date team was early in understanding that traditional fixed income allocations based on “core” U.S. investment‑grade sectors might be suboptimal for retirement investors. They recognized that:

The growth and evolution of global bond markets had created attractive diversification opportunities.

A larger opportunity set had expanded the field for skilled active management.

Dynamic diversifying allocations could better serve the needs of retirement investors at various points on the glide path.

We also were early in recognizing that defined contribution plan sponsors want more sophisticated fixed income allocations for their participants. One T. Rowe Price survey, for example, found that 79% of plan sponsors believe it is important to offer participants a range of fixed income options based on their risk, return, and retirement income preferences.⁷ By incorporating a broader range of asset classes within a target date solution, we believe we can bring a more sophisticated and risk‑aware approach to plan participants.

Conclusions

Overall, we believe the performance of our fixed income allocations testifies to the strengths of T. Rowe Price’s target date design process:

• prudent innovation backed by rigorous research;
• allocations that we seek to make durable under a variety of return, volatility, and correlation assumptions;
• rigorous scenario testing to analyze potential performance under varying market and/or economic conditions.

As always, we will continue to evaluate our allocations to ensure they reflect our best understanding of asset class relationships and capital market conditions. Our goal will remain the same: to construct portfolios that effectively further the long‑term objectives of target date investors.

Appendix

Important Information—Fixed Income Strategic Design
This material contains results based on glide path model allocations in the Appendix and past performance of T. Rowe Price mutual funds also shown in the Appendix. Past performance is not a reliable indicator of future performance. This material is not intended to forecast or predict future events, but rather to demonstrate the impact of the fixed income changes implemented within target date strategies. It does not reflect the actual returns of the target date funds and does not guarantee future results. Certain assumptions have been made and are unlikely to be realized. No representation or warranty is made as to the reasonableness of the assumptions made or that all assumptions used in the analysis presented have been stated or fully considered. Changes in the assumptions may have a material impact on the information presented. The results assume monthly rebalancing. Additionally, as the design reflects strategic weights, the results do not reflect the impact that material economic, market or other factors may have on weighting decisions which may be reflected in tactical changes. If tactical changes were reflected in the analysis, results would likely be different. Furthermore, as the fixed income allocation is evaluated, the results do not reflect those derived from the overall target date portfolio or fund, which also includes TIPS and equity exposure. The fixed income design results are derived from the actual NAV returns of T. Rowe Price mutual funds listed in the Appendix and reflects the reinvestment of dividends and capital gains. Actual investment results experienced by clients may vary significantly. The information is not intended as a recommendation to buy or sell any particular security, and there is no guarantee that results shown will be achieved.
T. Rowe Price Fund Returns: Returns shown in this analysis are based on the I Class shares of the underlying funds in the Retirement Funds portfolio. The Z Class shares that are actually held in T. Rowe Price’s target date funds do not charge a management fee. In addition, the Z Class shares did not have full track records for the 6-year period covered by our analysis.