FOR INSTITUTIONAL AND INVESTMENT PROFESSIONAL USE ONLY

In brief: ■ Target date fund risk profiles should align with evolving participant objectives along the retirement

savings journey and we believe fixed income plays a critical role in managing risk.

■ In our view, glide path construction should focus on managing risk and the distribution of potential future

returns, particularly for participants approaching retirement, as opposed to solely focusing on maximizing

returns. This more balanced approach should increase the likelihood of participants attaining their

desired outcomes.

■ Target date fund managers allocate fixed income along a glide path in many ways. We highlight this data

for sponsors and demonstrate how it can result in a wide variety of potential outcomes for participants.

■ We encourage sponsors to take another look — this time through a fixed income lens — at the plan's

target date glide path to ensure it aligns with the ultimate objectives of the retirement program.

Our 2019 white paper, "Rethinking the Role of Fixed Income Along the Retirement Savings Journey,"

portrayed the retirement savings journey as a framework that could help defined contribution (DC) plan

sponsors explore the types of fixed income exposure offered to participants. The paper established key

objectives for a participant's fixed income allocation and showed how these objectives evolve as a participant

ages, as outlined in Exhibit 1.

This paper takes the retirement savings journey from theory to practice by sharing our views on how

fixed income should evolve across a glide path, exploring both the absolute level of the fixed income

allocation and its composition in terms of fixed income sub-asset classes.

Exhibit 1: The retirement savings journey

For illustrative purposes only.

Accumulation Consolidation Decumulation

3 phases

Key participant goals Save and Grow Grow With Risk Awareness Protect and Generate Income

Key objectives for fixed income

Diversification from equities

Total return

Total return Lower the potential for capital losses Inflation risk management

Total return Lower the potential for capital losses Inflation risk management Income generation

Rethinking the Role of Fixed Income Along the Retirement Savings JourneyFrom Theory to Practice

MFS® White Paper

June 2020

Authors

Joseph C. Flaherty, Jr.Chief Investment Risk OfficerDirector of Quantitative Solutions

Natalie I. Shapiro, Ph.D.Portfolio Manager

Jonathan Barry, FSA, CFASenior Retirement Strategist

Jessica Sclafani, CAIADefined Contribution Strategist

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Fixed income along a glide pathA typical glide path illustration highlights the level of equity along the path, which reflects the DC industry's

historical focus on the accumulation phase of the retirement savings journey. To shine a spotlight on the fixed

income allocation within a glide path, we took the current glide path paradigm and turned it on its head. When

viewed this way, we typically see an upward slope in the glide path as participants' fixed income exposure

increases while the number of years until retirement declines.

Exhibit 2: Reverse glide path illustration■ Min. fixed income allocation ■ Avg. fixed income allocation ■ Max. fixed income allocation

MFS Investment Management® analysis based on the 25 largest target date mutual fund series by assets under management as of 31 December 2019 as provided by Morningstar Direct. Fixed income allocation includes dedicated fixed income strategies, excluding asset allocation funds and including cash. Please see endnotes for a list of these fund series.1

0%

20%

40%

60%

80%

100%

7565554535

Accumulation Consolidation Decumulation

Fixe

d in

com

e al

loca

tion

Age

In keeping with our theme of taking the retirement savings journey from theory to practice, the following are

questions we hear from sponsors around how to structure fixed income exposure along a glide path in terms

of level and composition.

Evaluating the level of fixed incomeAs Exhibit 2 illustrates, there is a wide range of practices in the allocation to fixed income along glide paths.

Depending on how much or how little fixed income a participant has at different points along the glide path,

retirement outcomes can vary significantly. We encourage sponsors to consider the level of the fixed income

allocation and how it evolves along the glide path when selecting and monitoring a target date fund.

Should early-career participants have exposure to fixed income?

The US Department of Labor's 2007 Qualified Default Investment Alternatives (QDIA) guidance states that

for a fund to qualify as a QDIA it must provide a mix of equity and fixed income exposures.2 Within this

context, sponsors should consider just how much fixed income exposure early accumulation phase

participants really need.

We encourage sponsors to consider the

level of the fixed income allocation

and how it evolves along the glide path

when selecting and monitoring a

target date fund.

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The average fixed income allocation for a participant invested in a 2050 target date fund is approximately

9.1%; however, the minimum and maximum allocations range between 1.5% and 19.9%, respectively. While a

larger fixed income allocation in far-dated vintages might feel "conservative," and therefore more comfortable

for some sponsors, it can potentially inhibit participants' ability to grow and compound their savings.

Exhibit 3: Top-25 largest target date mutual fund series — total dedicated fixed income allocation in 2050 funds

0%

5%

10%

15%

20%

Avg. fixed income allocationMax. fixed income allocationMin. fixed income allocation

1.5%

19.9%

9.1%

MFS Investment Management® analysis based on the 25 largest target date mutual fund series by assets under management as of 31 December 2019 as provided by Morningstar Direct. Fixed income allocation includes dedicated fixed income strategies, excluding asset allocation funds and including cash. Please see endnotes for a list of these fund series.1

In the accumulation phase of the retirement savings journey, which includes participants in their early 20s

through mid-40s, the most important objectives are to save as much as possible, maximize employer-

matching contributions and grow these savings through compounding investment returns. Accordingly, we

believe participants in this phase should have minimal fixed income exposure and seek to maximize capital

appreciation through the higher growth potential of equity and other higher-returning asset classes. With a

long time horizon until retirement, these participants have time to recover from market downturns and can

generally withstand the greater volatility associated with more risk exposure. A higher allocation to equities in

this phase can help build a larger retirement account balance, which can allow for participants to potentially

take less risk later.

By emphasizing capital appreciation through a relatively small fixed income allocation early in the glide path,

we can also begin to address longevity risk, one of participants' greatest concerns in retirement. Longevity risk

seems to be a topic most talked about as retirement approaches, but we believe this risk should be an explicit

objective across the retirement savings journey. Growing capital early on is as important as growing it and

protecting it later in life.

Participants in the accumulation

phase should seek to

maximize capital appreciation.

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How much fixed income exposure should participants have in the later years of the consolidation

phase and into the decumulation phase?

As discussed above, too much fixed income in the accumulation phase can inhibit a participant's ability to

benefit from compounding investment returns. In the consolidation and decumulation phases, we believe

too much equity exposes participants to excess drawdown and sequencing risk. We prioritize lowering the

potential for capital losses above capital appreciation in the later years, which requires greater exposure to

fixed income.

The range between the minimum and maximum fixed income allocations is significantly wider in near-dated

vintages when a participant is close to retirement age, indicating less agreement among target date managers

on how much to allocate to fixed income. While an analysis of the 2050 vintages shows a range of 18.4%

between the minimum and maximum fixed income allocations, the 2020 vintages exhibit a range of 47.2%.

These data illustrate the varying views of target date fund managers in determining an appropriate level of

fixed income exposure.

Exhibit 4: Top-25 largest target date mutual fund series — total dedicated fixed income allocation in 2020 funds

0%

20%

40%

60%

80%

100%

Avg. fixed income allocationMax. fixed income allocationMin. fixed income allocation

MFS Investment Management® analysis based on the 25 largest target date mutual fund series by assets under Management as of 31 December 2019 as provided by Morningstar Direct. Fixed income allocation includes dedicated fixed income strategies, excluding asset allocation funds and including cash. Please see endnotes for a list of these fund series.1

39.8%

87.0%

52.7%

We often hear the argument that participants nearing and in retirement should continue to hold a significant

allocation to return-seeking assets because they need a higher level of return for their savings to last through

a long lifespan. It is also sometimes argued that participants who have not saved enough must maintain a

return-seeking posture, which implies that late-career and retired participants can invest their way out of

suboptimal savings behavior. We believe that longevity risk can be managed in a number of different ways

and that higher equity allocations are not necessarily the most effective way to accomplish this. Furthermore,

participants who have been unable to save enough are generally more financially fragile and have less ability to

weather a market downturn, making a high-equity allocation late in the retirement savings journey potentially

even less appropriate.

Lowering the potential for

capital losses should be prioritized

above capital appreciation in the later years

of the retirement savings journey.

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We believe that near-dated vintages should hold a relatively high allocation to fixed income, with the goal

of lowering the potential for capital losses and managing sequence of returns risk. This can help to mitigate

the impact of significant market declines as participants approach their retirement date, when there is

less time to recover and a sharp drop in assets could have major implications, such as a postponement of

retirement and/or a reduction of a participant’s standard of living in retirement. In other words, a larger fixed

income allocation in near-dated vintages positions participants more conservatively at this crucial stage of the

retirement savings journey.

Theory to practice — The impact of fixed income allocations on participant outcomes

To explore this question of how much fixed income exposure participants approaching and in retirement

should have, we analyzed the impact of differing fixed income allocations on potential retirement outcomes

for two hypothetical participants under two hypothetical glide paths:

1) Glide Path 1, which starts with a fixed income allocation of 10%, reaches a 55% fixed income allocation at

age 65 and continues to increase throughout retirement

2) Glide Path 2, which starts with a fixed income allocation of 5% and reaches a 70% fixed income

allocation at age 65 that is held constant throughout retirement.

Source: Glide Path 1 with a 55% fixed income allocation at retirement is informed by MFS Investment Management® analysis of the top-25 largest target date mutual fund series by assets under management as of 31 December 2019 as provided by Morningstar Direct and represents an approximate average of these glide paths. See endnotes for the mutual fund series used in this analysis.1 “At retirement” is defined as age 65. See assumptions and methodologies for more details.

Exhibit 5: Glide Path 1 with a 55% fixed income allocation at retirement versus Glide Path 2 with a 70% fixed income allocation at retirement■ Glide Path 1 with 55% fixed income allocation at retirement ■ Glide Path 2 with 70% fixed income allocation at retirement

Accumulation Consolidation Decumulation

Fixe

d in

com

e al

loca

tion

as

a pe

rcen

tage

of t

otal

por

tfol

io

0%

10%

20%

30%

40%

50%

60%

70%

80%

7573716967656361595755535149474543413937353331292725Age

Glide Path 2 begins with a lower level of fixed income exposure and a correspondingly higher level of equity

exposure throughout the accumulation phase and into the consolidation phase. This relationship reverses

midway through the consolidation phase and into the decumulation phase, with Glide Path 1 landing at 55%

fixed income at age 65 versus 70% fixed income for Glide Path 2. All things being equal, Glide Path 2 should

A larger fixed income allocation

in near-dated vintages positions participants more conservatively at this crucial stage of the retirement savings journey.

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offer more opportunity for account growth in the accumulation phase while Glide Path 1 should offer the

opportunity for asset growth in the later phases of the retirement journey, when account balances are typically

larger and the effects of compounding investment returns more dramatic. Again, all things being equal, Glide

Path 1 should offer reduced volatility in the accumulation phase while Glide Path 2 should lower the potential

for capital losses in the consolidation phase, when account balances would typically be larger and the impact

of drawdowns more dramatic.

Using the glide paths illustrated in Exhibit 5, we simulated the range of potential outcomes for two

hypothetical participants — both age 45; with an initial account balance of $200,000; earning $80,000 per

year and receiving annual increases of 2.5%; and saving 10% of their earnings per year to see how their

account balance might look at age 65. In Exhibit 6 below, we show the results for each participant.3

Exhibit 6: Comparing hypothetical retirement outcomes

Participant X Retirement at age 65 Invested in Glide Path 1 with 55% fixed income allocation at retirement

Participant Y Retirement at age 65 Invested in Glide Path 2 with 70% fixed income allocation at retirement

Median projected account balance at 65 $1,053,000

Value at Risk (VaR) $111,000

What does this mean?

Hypothetical annual reduction in retirement income under a 1st

percentile market event

Participant X could lose 11% or more of account value in a 1st percentile market event, e.g., an extreme equity market correction

$1,042,000

$73,000

Participant Y could lose 7% or more of account value in a 1st percentile market event, e.g., an extreme equity market correction.

approximately $4,600

See assumptions and methodologies for more details.

Participant X has a Value at

Risk almost 50% greater than that of Participant Y 

approximately $6,900

We can see that the Participant X has a slightly higher median account balance at retirement than Participant

Y, which is a reflection of Participant X's higher allocation to return-seeking assets in the latter stages of the

retirement journey. However, simply comparing account balances at age 65 does not tell the whole story.

What is value at risk (VaR) and why is it important?

Value at risk is calculated using account balance and asset allocation data for individual

participants at a given point in time. Using this information, an expected return and standard

deviation is calculated for the participant. The VaR represents the estimated loss at the first

percentile of a normal distribution of outcomes, meaning that 1% of the time losses will be of

this magnitude or greater.

VaR can be an instructive metric in discussing a participant's potential experience along

the retirement savings journey and is particularly relevant for participants approaching

retirement who are vulnerable to sequence of returns risk.

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Looking at the results in Exhibit 6 from a risk perspective, Participant X has a value at risk4 approximately 50%

greater than that of Participant Y, which is a result of Participant X having a larger equity allocation. Comparing

the VaR of the participants reminds us that a glide path should not seek solely to maximize expected returns

but also account for managing the distribution of potential future returns. In this scenario, Participant X’s

annual retirement income is reduced by approximately $6,900 versus about $4,600 for Participant Y. While

both participants experience a decline in their retirement income in this scenario, Participant X would see a

larger impact in terms of standard of living during retirement.

These hypothetical scenarios are intended to help sponsors explore how their plan's glide path aligns with

the ultimate goals of their retirement program and how their unique participant population might view and

understand risk. Behavioral finance studies show that the pain of a dollar lost often outweighs the benefit of

a dollar gained. While the slightly greater upside potential of Glide Path 1 may be appealing, sponsors should

ask whether the benefit of that upside is worth the pain of potential downside outcomes for their participants

and the resulting impact on their ability to retire on time. The latter point also has an important impact on the

sponsor's ability to rotate the workforce, maintain employee productivity and morale.

Deconstructing the fixed income allocationThe retirement savings journey (Exhibit 1) illustrates the many objectives a participant's fixed income

allocation must achieve. We believe participants' fixed income exposure should offer diversification from

equities but also contribute to total return, lower the potential for capital losses, help manage inflation risk and

ultimately support income generation. Meeting these objectives can be a tall order for plans that rely primarily

on a core fixed income allocation for participants' exposure to bond markets. We encourage sponsors to

explore how incorporating fixed income strategies beyond a core fixed income allocation can help meet

participants' evolving needs.

What are the underlying strategies that could comprise the total fixed income allocation?

We believe in the broad diversification of fixed income throughout the glide path. Accordingly, we consider six

fundamental building blocks when constructing fixed income allocations along that path (see Exhibit 7). The

goal of constructing a diversified fixed income allocation is not to replace core bonds but rather to supplement

the core bonds allocation, which acts as a foundation to address additional participant objectives.

For illustrative purposes only.

Exhibit 7: Fixed income building blocks

Treasury Inflation-Protected

Bonds(TIPS)

Short-Term Bonds

High- Yield

Bonds

Emerging Markets

Debt (EMD)

Global Bonds

Core Bonds

We believe in the broad

diversification of fixed income throughout the

glide path.

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While participants do not always have exposure to every building block and the relative size of the allocation

depends on the participant's position along the retirement savings journey, we feel that this diversified

approach to fixed income exposure provides additional levers that can be employed to meet multiple

objectives.

Building a well-diversified fixed income allocation along a glide path

Many sponsors agree with the investment case for including exposures to fixed income strategies with higher

risk and return profiles, such as emerging markets debt or high yield, but refrain from doing so on the core

menu due to concerns that participants are not equipped to effectively allocate across these strategies. These

concerns, however, are alleviated when the fixed income allocation is packaged within a target date fund glide

path. We encourage sponsors to review the fixed income allocation within their target date fund and how it

evolves across the glide path.

Do off-the-shelf target date managers offer diverse fixed income exposure for participants?

Some of the largest target date managers rely predominantly on core bonds allocations — especially in near-

dated vintages (e.g., a 2020 fund) when the fixed income allocation is approximately equal to or greater than

half of the participant's total portfolio.

Source: MFS Investment Management® analysis based on the 25 largest target date mutual fund series by assets under management as of 31 December 2019 as provided by Morningstar Direct. Fixed income allocation includes dedicated fixed income strategies, excluding asset allocation funds and including cash. Core bonds includes the following categories: US Fund Intermediate Core Bond, US Fund Intermediate Core Plus Bond and US Fund Intermediate Government. Please see endnotes for a list of these fund series.11

Exhibit 8: Top-25 largest target date mutual fund series — Core bonds as a percentage of total dedicated fixed income allocation in 2020 funds

53%75%

18%

8%

53%

30%

11%

18%

19%

8%

4%4% 8%

Avg. core bonds as % of total FI

Max. core bonds as % of total FI

Min. core bonds as % of total FI

49.9%

36.7%

76.2%

We encourage sponsors to

review the fixed income allocation within their target date fund and how it evolves across the glide path.

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When we analyze the fixed income allocations of the 2020 vintages of the 25 largest target date mutual

fund series, we see that the number of underlying fixed income strategies employed ranges from three to

nine strategies. Furthermore, ten target date fund managers have more than half of their total fixed income

exposure invested in core bond strategies. Participants with high allocations to core bonds and limited

exposure to other fixed income strategies are potentially missing out on the diversification that could be

attained through broader access to the fixed income building blocks. We encourage sponsors to look at the

fixed income exposure in the target date fund and determine if it is appropriately diversified.

Conclusion

We believe that target date fund risk profiles should align with evolving participant objectives along the

retirement savings journey and that fixed income plays a critical role in managing risk. Glide path construction

should focus on managing risk and the distribution of potential future returns, particularly for participants

approaching retirement, as opposed to solely focusing on maximizing returns. This more balanced approach

should increase the likelihood of participants attaining their desired outcomes.

Target date fund managers allocate fixed income along a glide path in many ways. We highlight that for

sponsors and demonstrate how this can result in a wide variety of potential outcomes for participants. We

encourage sponsors to take another look — this time through a fixed income lens — at the plan's target date

glide path to ensure it aligns with the ultimate objectives of the retirement program.

We encourage sponsors to

look at the fixed income exposure

in the target date fund and determine if it

is appropriately diversified.

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Assumptions and methodologies

Returns, risk and correlations used in Exhibit 6

US Large-

Cap Equities

Non-US Equities

US Aggregate

Bonds

Global Aggregate

Bonds

Global High- Yield

Bonds

Emerging Market

DebtUS TIPS

Short- Term Bonds

Geometric Return (%) 7.1% 7.1% 3.7% 3.5% 5.3% 6.0% 3.8% 2.7%

Risk (%) 13.8% 16.4% 3.2% 2.6% 8.8% 7.8% 5.5% 2.0%

Correlation

US Large-Cap Equities 1.00

Non-US Equities 0.87 1.00

US Aggregate Bonds (0.02) 0.08 1.00

Global Aggregate Bonds (0.08) 0.01 0.93 1.00

Global High-Yield Bonds 0.71 0.77 0.26 0.16 1.00

Emerging Market Debt 0.53 0.65 0.59 0.51 0.81 1.00

US TIPS 0.13 0.22 0.77 0.66 0.42 0.64 1.00

Short-Term Bonds (0.06) 0.02 0.04 0.02 (0.10) (0.03) 0.02 1.00

Source: MFS Long Term Capital Market Expectations, as of January 2020. Forward-looking expectations are annualized geometric total return and risk for a 30-year time horizon. Risk is defined as annualized monthly standard deviation. Equity forecasts are unhedged in USD. Fixed Income forecasts are hedged in USD. References to future expected returns and performance are not promises or estimates of the actual performance realized by an investor, and should not be relied upon. The forecasts are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation, or be guarantees of performance. The forecasts are based on subjective estimates and assumptions that have yet to take place or may occur. The projections have limitations because they are not based on actual transactions but instead on the models and data compiled by MFS. The results do not represent or indicate actual results that may be achieved in the future. Individual investor performance may vary significantly.

Glide path assumptions used in Exhibit 5 and Exhibit 6

Glide Path 1 with 55% fixed income allocation at retirement

AgeUS Large- Cap

EquitiesNon-US Equities

US Aggregate Bonds

Global Aggregate

Bonds

Global High-Yield Bonds

Emerging Market Debt

US TIPSShort- Term

Bonds

45 55.0% 30.0% 10.0% 1.0% 1.0% 1.0% 1.0% 1.0%

55 45.0% 22.5% 21.0% 2.5% 2.0% 1.0% 3.0% 3.0%

65 30.0% 15.0% 30.0% 4.0% 3.0% 1.0% 8.0% 9.0%

Glide Path 2 with 70% fixed income allocation at retirement

AgeUS Large- Cap

EquitiesNon-US Equities

US Aggregate Bonds

Global Aggregate

Bonds

Global High-Yield Bonds

Emerging Market Debt

US TIPSShort- Term

Bonds

45 65% 25% 2.5% 0.0% 2.5% 2.5% 2.5% 0.0%

55 47.5% 17.5% 15.0% 5.0% 5.0% 5.0% 5.0% 0.0%

65 20.0% 10.0% 30.0% 5.0% 2.5% 2.5% 10.0% 20.0%

Glide Path 1 is informed by an MFS Investment Management analysis of the top 25 largest target date mutual fund series by assets under management as of 31 December 2019 provided by Morningstar Direct and represents an approximate average of these glide paths. Glide Path 2 is similar though not identical to the MFS® Lifetime® Funds’ glide path. “At retirement” is defined as age 65.

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Participant assumptions used in Exhibit 6 ■ The participant's retirement income need increases 2.5% annually.

■ The participant has a starting balance of $200,000 at age 45.

■ The participant earns $80,000 per year and receives a 2.5% raise annually, saving 10% of earnings per

year (a combination of participant savings and employer match).

■ The participant needs 70% income replacement at age 65. Life expectancy is 20 years from age 65.

Social Security provides 27% of final pay prior to retirement, with 401(k) account providing the

remaining 43%.

Investment returns were modeled using a Monte Carlo simulation generated by Oracle Crystal Ball software.

Asset returns, risks (standard deviations) and correlations noted above were used to generate a normal

distribution of outcomes for each asset class. 2,000 potential outcomes were generated to calculate the

various percentiles of account balances.

Endnotes1 The 25 largest target date mutual fund series by assets under management, as of 31 December 2019, provided by Morningstar Direct include

Vanguard Target Retirement Funds (including Vanguard Institutional Target Retirement assets), Fidelity Freedom Funds, American Funds Target Date Retirement Series, T. Rowe Price Retirement (including T. Rowe Price Retirement I assets), Fidelity Freedom Index Funds, JPMorgan SmartRetirement, BlackRock LifePath Index Funds, TIAA-CREF Lifecycle Funds, TIAA-CREF Lifecycle Index Funds, Principal LifeTime Funds, Fidelity Advisor Freedom Funds, American Century Once Choice Target Date Portfolios, KP Retirement Path Funds, JPMorgan SmartRetirement Blend, State Street Target Retirement Funds, John Hancock Multi-Index Preservation Portfolios, John Hancock Multimanager Lifetime Portfolios, Great-West Lifetime Funds, Voya Index Solution Portfolios, MassMutual Select T. Rowe Price Retirement Funds, USAA Target Retirement Funds, Fidelity Freedom Blend Funds, Schwab Target Funds, GuideStone MyDestination Funds, and MFS Lifetime Funds.

2 A DOL Field Assistance Bulletin issued in April 2008 addressed the question, "Can an investment fund or product with zero fixed income qualify as a QDIA?" by reiterating the view that a QDIA must include some fixed income exposure.

3 Estimated account balances for glide path with 55% fixed income allocation at retirement versus glide path with a 70% fixed income allocation at retirement.:

Percentile Glide Path 1 Glide Path 2Difference ($)

(Glide Path 1 – Glide Path 2)Difference (%)

5th percentile $595,000 $595,000 $0 0%

25th percentile $820,000 $821,000 -$1,000 -0.1%

50th percentile $1,042,000 $1,053,000 -$11,000 -1.0%

75th percentile $1,308,000 $1,333,000 -$25,000 -1.9%

95th percentile $1,800,000 $1,840,000 -$40,000 -2.2%

4 Value at risk is based on the account balance and asset allocation of each participant at his or her current age. An expected return and standard deviation is calculated for each participant based on his or her asset allocation, and the value at risk is the estimated return at the 1st percentile of a normal distribution of outcomes.

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