For the Love of Money – The O’Jays

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Published on December 9, 2019

| 7 min read

Jim McHugh, Senior Managing Director, Business Development


Our industry lives in a world of ratios. We love derivatives, but in the end, it’s all about tangible results: money. In a defined contribution context, financial outcomes are what really matter to your participants, and one of the biggest factors on those outcomes is risk management. In this post, we pick up where we left off in an earlier post about adding variable beta strategies to an asset allocation model, but this time we show you the money effect. Just don’t let it change you.

Quick Recap

In our earlier post, we introduced a case study for using variable beta strategies in a target-date strategy. Even well-diversified target-date strategies expose participants to a lot of risk because equities are often the largest risk source in the portfolios. Rebalancing, reallocating and market timing are not enough to offset the risk equities pose.

We contend that you can add to this risk-management toolbox by substituting a portion of your equity allocation with a variable beta strategy. We compared three use-cases:


BC: Base Case, Our Base Case reflects the Morningstar Lifetime Moderate Index with a zero allocation to variable beta. RV: Reduce Volatility, The Reduced Volatility model seeks to reduce Base Case volatility while maintaining total equity exposure. MV: Match Volatility, The Match Volatility models seeks to match Base Case volatility while increasing total equity exposure.

Three Use Cases - black font


The Reduced Volatility model might be a helpful scenario for asset allocators who can’t or won’t change their strategic allocations. By substituting one-third of the Base Case equity allocation with a variable beta strategy, we illustrated that we could reduce Base Case volatility throughout the glide path and maintain the overall equity exposure.1

The Matched Volatility model might be a helpful scenario for asset allocators who have the flexibility to change their strategic allocations. By substituting one-third of the Base Case equity allocation with a variable beta strategy, we demonstrated that we could match Base Case volatility while increasing equity exposure throughout the glide path.2

Just Show Me the Money

Potential Pros and Cons of Common Remedies, Alternatives, Pros: Lower Equity Correlation, Expanded Opportunities, Inflation Hedge, Cons: Higher Fees, Liquidity Risks, Hidden Equity Beta. Factor Exposures, Pros: Targeted Risk Exposures, Lower Correlation Between Factors, Cons: Transient Performance, Overcrowding Risks, Spurious Modeling. Fixed Income, Pros: Lower Equity Correlation, Capital Preservation, Income Generation, Cons: Interest Rate Risk, Credit Risk, Longevity Risk. Tactical Decisions, Pros: Enahcned Returns, Lower Risk, Cons: Market Timing is Difficult, Implementation Costs, Governance Costs.

While we showed how variable strategies could modify your target-date strategy’s risk profile, we didn’t show the potential wealth implications for participants. To understand those effects, below we examine the cumulative wealth differences between the Base Case, Reduce Volatility and Match Volatility models over the 20 years ended Dec. 31, 2018.

Early-Career Impact

During the early-career phase, participants have a high allocation to equities. The rationale is that younger participants who experience a down market have more time to regain principal. Mitigating negative returns during this phase helps improve the compounding effect over the first 20 years of a participant’s career. At the end of this period, accumulated wealth for the RV model is 4.9% higher than the Base Case. Wealth for the MV case is 9.8% higher.




Late-Career Impact

Equity exposure begins to fall significantly in most glide paths during the late-career stage. Here downside protection becomes increasingly critical. Mitigating overall portfolio risk and negative returns in this phase is especially important during the years just before retirement when the sequence of returns can dramatically reduce portfolio life. A variable beta strategy can help in this stage by reducing the magnitude of negative returns. During this period, the RV model generates 13% more wealth and the MV model generates 16.4% more relative to the Base Case model.





Finally, in-retirement phase, participants are expected to withdraw capital to live on, but doing so in down markets is especially damaging to portfolio longevity. At the same time, people are living longer in retirement, so maintaining equity exposure is vital. Variable beta can help here too. During this period, wealth for the RV and MV models are 12.1% and 16% higher than the Base Case, respectively.




Don’t Let the Money Change You

Today’s widespread adoption of target-date strategies is a testament to their benefits, but they are not immune to equity risk – risk that can materially affect financial outcomes. Participants can find themselves swept up in equity market downturns despite the strong diversification offered by these strategies.

But there’s a path for potentially changing this experience. Variable beta strategies allow portfolio managers to make their strategic asset allocation models more dynamic without changing their long-term risk and return assumptions because these strategies can adapt to market risk regimes within existing allocation models.

It is possible to magnify these benefits in the context of a defined contribution plan, because reduced volatility may encourage better savings behavior, which massively affects wealth outcomes. See the full case study in our latest eBook, “Are Your Asset Allocation Models Exposed Right Now?

Are Your Asset Allocation Models Exposed Right Now? Learn about an innovative way to address equity risk in your portfolio. Download Now



1. The full asset history of asset class returns is used to calculate the covariance matrix, and the same matrix is used for each fund (or retirement year); therefore, the change in volatility comes from differences in target-date fund weights.

2. The increase in equity exposure to 100% in the early-career stage creates a bigger gap in volatility between the funds since we cannot increase the equity portion further to achieve the same volatility as the Base Case.

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