FOCUS ON
THE LONG RUN
The Potential Diversification Benefits of Long
Government Bonds in the Target Date Glidepath

State Street Global Advisors differs fromother passive providers in its dedicatedexposure to long government bonds in ourtarget date funds for younger investors.
Long government bonds have been oneof the best-performing fixed income
instruments in our glidepath over thelast five years as interest rates havecontinued their downward trend. This has
led some investors to question whether
our long bond exposure could become adisadvantage if the secular downward
trend in interest rates has now reversed.
In this paper we explore the diversification effects of long bonds and study the impact thata rise in interest rates would have on target date investors in more detail. Long government
bonds can play a valuable role in early phases of the glide path, both because they are
consistent with the long-dated future liabilities of younger participants and because they
can provide meaningful diversification benefits at a time when the portfolio is heavily
tilted towards equities. Furthermore, by breaking our fixed income allocation down into
components, rather than relying almost exclusively on the Bloomberg Barclays Aggregate
Index1 (the “Agg”) like many of our competitors, we seek to achieve more precision in
mitigating the key risks faced by participants at different stages of their life cycle.
This paper contains a case study from 2016 of the expected impact of higher interest rates
on target date investors. While rising interest rates would probably lead to a short-termdrag on performance, target date investors are less exposed to this than lump-sum
investors, and in the longer run, participants would be expected to profit from higher
yields. The expected diversification benefits and the ability to more closely mirror
participant liabilities continue to justify including long bonds in the target date glidepath.

1

BLOOMBERG®, is a trademark and service mark of Bloomberg Finance L.P. and its affiliates, and BARCLAYS®,
is a trademark and service mark of Barclays Bank Plc.

Negative Correlation with Equities Provides
Diversification Benefits
In recent decades, long government bonds have provided
diversification to portfolios, thanks to their negative correlation
with equity prices. When equity prices have fallen, bond prices
have typically risen, offsetting the decline in portfolio values.
This effect has been particularly marked for long-duration
Figure 1: Asset Class Index Correlations
S&P 500
Index

Russell
Completeness Index

MSCI ACWI
ex USA IMI Index

Long Government Bonds

-0.26

-0.28

-0.21

US Aggregate

0.01

-0.02

0.11

US TIPS

0.13

0.13

0.25

1–3 year Gov/Credit

-0.07

-0.09

0.07

US High Yield

0.69

0.70

0.74

Source: FactSet, SSGA. Period January 2003–September 2018. Indices used in
calculations: Bloomberg Barclays US Aggregate, Bloomberg Barclays Capital Long
Government Bond Index, Bloomberg Barclays Capital US TIPS Index, Bloomberg
Barclays Capital 1-3 Yr Gov/Credit Index, Bloomberg Barclays High Yield Very
Liquid Index, MSCI AC World ex USA IMI Index, S&P 500 Index, Russell Small Cap
Completeness Index.

government bonds; while the Agg index has provided a low
positive correlation, long government bonds have most reliably
provided a clear negative correlation (Figure 1).
Bond prices have not always been negatively correlated withequity prices. Indeed, over much of history the correlation
between the two asset classes has been positive. The current
period of sustained negative correlation dates back to the Asianfinancial crisis in the late 1990s (Figure 2) and is probably aconsequence of central banks’ policy of systematicallyloosening monetary policy in response to economic shocks.
This environment seems likely to persist. For example,
following the vote for Brexit, markets immediately assumed
that central banks would adopt looser monetary policy inresponse. Academic research also shows that stock and bondprices tend to be negatively correlated in periods of low
inflation and low economic growth, such as we are currently
experiencing.2,3 For these reasons, it is reasonable to assume
that long government bonds will continue to have a negative
or very low correlation with equities and thus play a useful
diversifying role in the target date portfolio.

Figure 2: The Negative Correlation Between Equities and Long Government Bonds Since the Asian Crisis
Correlation (Long Govt S&P 500)
1.00

0.50

0.00
Correlation
Long Govt Index
to S&P 500 Index

-0.50

-1.00

-1.50

LehmanBrothers
Bankruptcy

Asian
Financial
September 11
CrisisTerrorists Attacks

1973

1977

1981

1985

1989

1993

1997

2001

2005

2009

Fed “Tapers” QE

2013

2017

Source: SSGA calculations. Indices used in the calculation: Bloomberg Barclays Capital Long Government Bond Index, S&P 500 Index Data as of September 30, 2018.

2
3

Ilmanen, Antti, “Stock-Bond Correlations,” Journal of Fixed Income, vol. 13, no. 2 (September 2003), 55–66.
Rankin, Ewan and Muhammed Shah-Idil, “A Century of Stock-Bond Correlations,” Reserve Bank of Australia Quarterly Bulletin (September 2014).

State Street Global Advisors

2The Benefits of Diversification & Liability Matching

Case Study
Target Date Investors Recover from Rising
Yields Faster than Lump Sum Investors
A common concern for investors is the potential for longgovernment bonds to detract value from the portfolio ifinterest rates finally rise from their current extremely low
level. If interest rates start to rise, this will indeed have an
initial negative impact on long bond investors. However,rising interest rates are not all bad news for investors. As rates
rise, the yield on the bonds in a portfolio also rises; this effecthelps to offset the capital loss. Furthermore, a target dateinvestor, making biweekly contributions, benefits from thehigher yield more quickly than a lump-sum investor because
each subsequent contribution is made at a higher yield (orlower price).

In our case study, we examined three recent periods ofrising interest rates to see how long it would have taken an
investor making monthly contributions to recoup theirinitial investment in the long bond index (Figure 3). As we
can see, this period has steadily become longer as rates havefallen ever lower, but even in the recent interest-rate cycle,
when rates rose by about 1.5 percentage points from July 2012
to December 2013, after 21 months the monthly investor would
already have reached breakeven (assuming they started making
contributions when interest rates were at their lowest point).
The advantage of the monthly investor compared with the
lump-sum investor has also steadily widened as rates havefallen ever lower in each subsequent interest-rate cycle.

Figure 3: Target Date Investors Have Benefited from Higher Yields Faster than Lump-Sum Investors
Months to Breakeven During Periods of Rising Interest Rates

10-Year Yield

30

6
28

20

Lump-Sum
TDF Investor
Investor
16
14

20

21

5
4
3

16

10

2
Periodsof RisingInterest Rates

10

2003–2006

2009–20102012–2014

0

2003

2005

2007

2009

2011

2013

2015

2018

Source: SSGA calculations. Months to breakeven calculated first for a hypothetical target date investor making monthly contributions of $100 to the Bloomberg Barclays CapitalLong Government Bond Index. The breakeven for the lump-sum investor is calculated by taking the total sum invested by the target date investor until breakeven and investing
this amount at the start of the period in the same long government bond index.
Performance of an index is not illustrative of any particular investment. It is not possible to invest directly in an index. Index returns reflect capital gains and losses, income, andthe reinvestment of dividends.
Past performance is not a guarantee of future results.
The above chart is for illustrative purposes only.

3

Case Study
Figure 4: Value of the Example Long Government Bond Portfolio for a Participant Making $100 Annual Contributions
in Different Interest Rate Scenarios$
3,500
No Change to Rates

2,500
2,000

Typical Rising Rates

1,500

Rates Return to Long-run Average

1,000
500
0

25

26

27

28

29

30

35

45

Age of Participant

SCENARIO A

No Change to Rates
Interest rates remain at theircurrent level for the next 20 years

SCENARIO B

SCENARIO C

Typical Rising Rates
Interest rates rise 0.75 percentage
points each year in years 1 and 2
and then stabilize. An increase of
1.5 percentage points over 2 years
is fairly typical of recent risingrate cycles

Rates Return toLong-run Average
Interest rates rise 0.75 percentage
points in years 1 and 2 and thenrise another 0.5 percentage points
to their long-run average level(since 2000) in year 3

Source: SSGA calculations based on a parallel shift in the yield curve using the yield curve for 6/30/2016. The above hypothetical scenarios are based on certain assumptions andanalysis made by SSGA. There is no guarantee that the estimates will be achieved. Returns reflect capital gains and losses, income, and the reinvestment of dividends. Returns areunmanaged and do not reflect the deduction of any fees or expenses.

The Overrated Fear of Rising Interest Rates
As an alternative way of studying the impact that a rise ininterest rates would have on a portfolio, we simulated aparallel shift in a portfolio that is invested in the longgovernment bond index with maturities from 10 to 30 years.
In this case study, we used the level of interest rates at theend of June 2016 as our starting point. With the benefit ofhindsight, this was actually very close to the bottom of thecurrent rate cycle. We then studied the three resulting
scenarios (Figure 4) for a participant who starts making
annual contributions of $100 at the age of 25.
In both hypothetical rising rate scenarios, the bond investor
initially sustains losses of 7%–9% in the years in which yields

rise. However, the benefits of the higher yields soon makethemselves felt in the portfolios — by the time the participant
is 30, the value of the portfolio in the rising rates scenario isalmost the same as the scenario in which interest rates stay atcurrent levels. The value of the portfolios in both rising rates
scenarios exceeds that of the stable interest rates scenario in
the year when the participant reaches 33.
These calculations are based on an investor making annual
contributions, but we know that most target date investors
make bi-weekly contributions. As we showed in Figure 3,
an investor making frequent contributions could expect toreap the benefits of higher yield levels more rapidly, so thissimulation probably overstates the time it would take forthe target date investor to benefit from higher yields.

State Street Global Advisors

4The Benefits of Diversification & Liability Matching

Figure 5: SSGA Provides a More Detailed Fixed-Income
Portfolio Breakdown Than Our Competitors
Asset Classes

SSGA

Provider A

Provider B

Fixed Income

Long Government
Core Aggregate
Cash or ST Gov’t/Credit
US High Yield
International Developed Debt
Emerging Markets Debt
Inflation Protection

Inflation-Linked Bonds (TIPS)
Commodities
REITS
Source: SSGA analysis based on publicly available information as of December 31,
2018. Provider A and B chosen as sample passive target date competitors due tohighest AUM among comparable investment strategies. Competitor info sourced
from fact sheets. The information contained above is for illustrative purposes only.

Tailoring the Glide Path’s Risk with a
Granular Approach
SSGA employs a granular approach within the fixed income
allocation in the target date glidepath, dynamically adjusting
the composition of the fixed-income portfolio at different
phases of the retirement saving journey. This allows us to moreclosely match the composition of the portfolio to the key risks
faced by participants in different phases. Compared with ourcompetitors, we employ more asset classes within our fixedincome allocation (Figure 5). While our competitors maintainessentially a stable fixed income duration throughout their
glidepath, SSGA tailors the duration of the fixed income
glidepath to each stage of the participant’s lifecycle, startingat a high level and gradually falling as participants approachretirement (Figure 6). The declining duration of the fixedincome portfolio reflects the falling duration of participants’retirement liabilities as they age.
In the early stages of retirement saving, participants have a long
investment horizon. This implies both a high risk tolerance,
which is reflected in the high equity weight at this stage, and along duration of retirement liabilities. Long government bonds

Figure 6: SSGA Strategically Manages Interest Rate Risk, While Competitors Maintain Static Duration
OA Duration of Fixed Income Allocation
18
15

Intermediate/Short Duration
Reduced interest-rate exposure
Increased sector diversiﬁcation with focus
on addressing key market and inﬂation risksLong Duration
Diversiﬁcation versus equity allocations
Interest-rate risk mitigated by a longer
time horizon to reinvest at higher yields
Allows longer retention of growth
assets by hedging short-fall risks

12
9
6
3
0

25

30

— SSGA Fixed Income Duration

35

40

45

50
Age

55

60

65

70

— SSGA Total Target Date Portfolio Duration

Source: State Street Target Retirement Strategies strategic asset allocation roll-down schedule as of September 30, 2018. Updated annually.
Competitor information sourced from fact sheets and/or prospectuses.
Fixed Income asset class statistics sourced from Bloomberg Barclays POINT as of September 30, 2018. Updated annually.
The information contained above is for illustrative purposes only. Past performance is not a guarantee of future results. Please refer to the disclosure slide for additionalrisk disclosures.
Allocations are as of roll-down schedule date indicated, are subject to change, and should not be relied upon as current thereafter.

575

perform a valuable role at this stage, both by diversifying equity risk and matching theduration profile of retirement liabilities.
As participants approach retirement, their risk tolerance and the duration of their
liabilities typically fall. We start to reduce the allocation to long government bonds 10 years
before the fund vintage reaches its target date. By the time the fund has reached the target
date, it no longer contains any long government bonds. As participants prepare to draw
down their savings in retirement, managing inflation risk becomes more important, andwe increase our allocation to TIPS (Treasury Inflation Protected Securities). In the
decumulation phase, the fixed income portfolio consists of the Agg, short-duration
treasuries and corporates, TIPS and high-yield bonds.

Long Government Bonds Continue to Play a Valuable Role in
the Target Date Glidepath
We believe that long-duration government bonds continue to be a valuable componentof target date funds for early vintages, as they offset equity risk at the time when the equity
weight is at its highest. Based on academic research, the economic environment is likely tosupport a low or negative correlation between stocks and long-dated bonds in the coming
years. In this case, long government bonds would be expected to continue to provide
valuable diversification benefits to early stage target date investors with high levels ofequity risk. It is true that in view of the current low level of interest rates, long-dated bonds
are unlikely to perform as strongly going forward as they have over the past few decades,
but this is also true for all longer-duration fixed income in general. Our allocation decisions
are based on our long-term forecasts rather than short-term tactical decisions, and thisprovides our glidepath with an important element of consistency.
Fears regarding the negative impact of rising bond yields are likely to be exaggerated.
If bond yields rise, long bond investors will initially suffer losses, but these will be offset
by higher future yields on the bond portfolio. Furthermore, target date investors, whotypically make biweekly contributions, could reap the benefits of higher interest rates
faster than a lump-sum investor, as they are essentially dollar-cost averaging their
exposure. We believe long government bonds continue to play a valuable role in the
glidepath, despite the potential for rates to rise from current levels.

State Street Global Advisors

6About State Street Global Advisors
For nearly four decades, State Street Global Advisors has
been committed to helping our clients, and those who rely on
them, achieve financial security. We partner with many of theworld’s largest, most sophisticated investors and financial
intermediaries to help them reach their goals through arigorous, research-driven investment process spanning
both indexing and active disciplines. With trillions* in assets,
our scale and global reach offer clients access to markets,geographies and asset classes, and allow us to deliver thoughtful
insights and innovative solutions.
State Street Global Advisors is the investment management armof State Street Corporation.
*A UM reflects approximately $28.32 billion (as of September 30, 2018), with respect
to which State Street Global Advisors Funds Distributors, LLC (SSGA FD) serves asmarketing agent; SSGA FD and State Street Global Advisors are affiliated.

ssga.com/definedcontribution
State Street Global Advisors One Iron Street, Boston MA 02210.
T: +1 866 787 2257.

date and beyond. The investment risks of each Fund change over time as its asset
allocation changes.

Investing involves risk including the risk of loss of principal.
The whole or any part of this work may not be reproduced, copied or transmitted or
any of its contents disclosed to third parties without SSGA’s express written consent.

Dollar cost averaging does not assure a profit or protect against a loss in declining
markets. For the strategy to be effective, you must continue to purchase shares bothin market ups and downs.

All information has been obtained from sources believed to be reliable, but its
accuracy is not guaranteed. There is no representation or warranty as to the current
accuracy, reliability or completeness of, nor liability for, decisions based on suchinformation and it should not be relied on as such.

Assumptions and forecasts used by SSGA in developing the Portfolio’s asset allocation
glide path may not be in line with future capital market returns and participantsavings activities, which could result in losses near, at or after the target date year or
could result in the Portfolio not providing adequate income at and through retirement.

The views expressed in this material are the views of DC Investment Strategy Teamthrough the period ended December 31, 2018 and are subject to change based onmarket and other conditions. This document contains certain statements that may bedeemed forward-looking statements. Please note that any such statements are notguarantees of any future performance and actual results or developments may differ
materially from those projected.

Increase in real interest rates can cause the price of inflation-protected debt
securities to decrease. Interest payments on inflation-protected debt securities canbe unpredictable.

Bonds generally present less short-term risk and volatility than stocks, but containinterest rate risk (as interest rates rise, bond prices usually fall); issuer default
risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usuallypronounced for longer-term securities. Any fixed income security sold or redeemed
prior to maturity may be subject to a substantial gain or loss.
Government bonds and corporate bonds generally have more moderate short-term
price fluctuations than stocks, but provide lower potential long-term returns.
Diversification does not ensure a profit or guarantee against loss.
SSGA Target Date Fund are designed for investors expecting to retire around theyear indicated in each fund’s name. When choosing a Fund, investors should consider
whether they anticipate retiring significantly earlier or later than age 65 even if suchinvestors retire on or near a fund’s approximate target date. There may be otherconsiderations relevant to fund selection and investors should select the fund thatbest meets their individual circumstances and investment goals. The funds’ asset
allocation strategy becomes increasingly conservative as it approaches the target

Investing in REITs involves certain distinct risks in addition to those risks associatedwith investing in the real estate industry in general. Equity REITs may be affected bychanges in the value of the underlying property owned by the REITs, while mortgage
REITs may be affected by the quality of credit extended. REITs are subject to heavy
cash flow dependency, default by borrowers and self-liquidation. REITs, especiallymortgage REITs, are also subject to interest rate risk (i.e., as interest rates rise, thevalue of the REIT may decline).
Investing in commodities entail significant risk and is not appropriate for all
investors. Commodities investing entail significant risk as commodity prices can be
extremely volatile due to wide range of factors. A few such factors include overallmarket movements, real or perceived inflationary trends, commodity index volatility,international, economic and political changes, change in interest and currency
exchange rates.
Investing in high yield fixed income securities, otherwise known as junk bonds, isconsidered speculative and involves greater risk of loss of principal and interest thaninvesting in investment grade fixed income securities. These Lower-quality debt
securities involve greater risk of default or price changes due to potential changes
in the credit quality of the issuer.

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