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September 29, 2010

Asset Allocation: The Glide Path Debate

Rich Weiss
Senior Vice President
Senior Portfolio Manager

FOR INSTITUTIONAL USE ONLY / NOT FOR PUBLIC USE


American Century Investment Services, Inc. – Distributor
©2010 American Century Investments Proprietary Holdings, Inc. All rights reserved.
Asset Allocation: The Glide Path Debate
Three Current Issues

• “To” versus “Through” Design

• Optimal Equity (Risk) Exposure

• Effective Diversification

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“To” versus “Through” Design
Age and Risk: Competing Academic Theories

Risk
Exposure
(Tolerance)

Age

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“To” versus “Through” Design
Age, Wealth, and Risk

 Accumulation Distribution 

Wealth

r*

Age

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“To” versus “Through” Design
Convex or Concave?

“Through”
Glide Path

Wealth Risk
“To” Glide Tolerance
Path

r*

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“To” versus “Through” Design
Our Position

• Both proprietary and independent research support “To”


methodology “Through”

• Flatter glide paths around retirement exhibit higher likelihood of “To”

retirement “success”
r*
• Statistical analysis shows significant differences in probability of
running out of money in retirement

• Higher risk allocation at retirement contradict intuition, theory,


and investor behavior

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Asset Allocation: The Glide Path Debate
Three Current Issues

• “To” versus “Through” Design

• Optimal Equity (Risk) Exposure

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Optimal Equity (Risk) Exposure
Rule of Thumb

e* = (100 – Age)
where e* = optimal equity exposure

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Optimal Equity (Risk) Exposure
Longevity Risk: Scenario #1

Probability of Running Out of Money in Retirement


4% Withdrawal Rate
100%
Probability of Running Out of Money

80%

60%

40%

80%
Equity
20% 60%
Allocatio
40%
n
20%
Percenta
0% ge
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29

Years in Retirement

Data as of 7/31/2010
10078 Source: Bloomberg

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Optimal Equity (Risk) Exposure
Longevity Risk: Scenario #2

Probability of Running Out of Money in Retirement


6% Withdrawal Rate
100%
20%
Probability of Running Out of Money

Equity
80% 40% Allocatio
n
60% Percenta
80% ge
60%

40%

20%

0%
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29

Years in Retirement

Data as of 7/31/2010
10078 Source: Bloomberg

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Optimal Equity (Risk) Exposure
Longevity Risk: Scenario #3

Probability of Running Out of Money in Retirement


8% Withdrawal Rate
20%
100% 40% Equity
60% Allocatio
Probability of Running Out of Money

80% n
80% Percenta
ge

60%

40%

20%

0%
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29

Years in Retirement

Data as of 7/31/2010
10078 Source: Bloomberg

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Optimal Equity (Risk) Exposure
The “Sweet Spot”

Risk
Exposure

45%
35%

r*

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Asset Allocation: The Glide Path Debate
Three Current Issues

• “To” versus “Through” Design

• Optimal Equity (Risk) Exposure

• Effective Diversification

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Asset Class Performance Over Time

There is no pattern to performance !

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
66.41% 31.84% 13.93% 25.91% 56.28% 31.58% 34.54% 35.06% 39.78% 12.81% 79.02%

26.96% 26.37% 8.96% 20.13% 47.25% 25.95% 21.36% 32.59% 16.23% 5.08% 55.19%

26.47% 10.12% 5.44% 9.84% 38.59% 20.25% 13.54% 26.34% 11.17% 1.77% 31.78%

24.35% 6.08% 4.07% 3.82% 37.13% 18.33% 12.16% 18.37% 11.00% 21.39% 27.99%

21.26% 4.07% 2.80% 1.70% 30.62% 13.55% 8.70% 15.80% 10.27% -24.40% 27.17%

21.04% 3.71% 2.49% 1.01% 28.70% 10.93% 7.50% 15.19% 8.24% -25.91% 26.47%

16.81% -3.02% -2.03% -0.33% 27.02% 10.87% 4.91% 11.85% 7.39% -33.79% 26.05%

4.80% -3.46% -2.37% -1.53% 23.93% 10.79% 4.55% 10.39% 5.49% -35.65% 18.91%

1.73% -5.68% -4.87% -6.00% 16.73% 9.15% 3.00% 5.74% 4.78% -37.00% 11.47%

0.39% -9.11% -11.88% -15.94% 11.62% 6.87% 2.08% 4.80% 1.84% -37.73% 5.24%

-3.91% -14.17% -19.51% -20.48% 4.31% 3.04% 1.58% 4.08% -1.57% -43.38% 3.14%

-4.62% -30.61% -21.44% -22.10% 1.03% 1.24% -9.49% 2.07% -15.69% -53.18% 0.15%
Cash Core Bond High Yield Bonds Russell 2000 S&P 500 Diversified Portfolio
Int'l Bonds EAFE EmergingMarkets REITS Hedge Funds Commodities
Data as of 7/31/2010
10078 Source: Bloomberg

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Performance of a Diversified Portfolio Over Time
Diversification remains an investor’s best friend

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

13.55% 8.70% -24.40%

3.71% 15.19% 8.24%

16.81% -2.03% -0.33% 27.02% 26.05%

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Diversification
The Obvious Benefits

Asset Class Return Volatility Sharpe Ratio

Base Case: Balanced Portfolio


(60% S&P / 40% Barclays Agg) 8.0% 9.3% 0.45

Inject 10% exposure to:

Real Estate (REITs) 8.3% 9.1% 0.49

Emerging Market Equities 8.4% 9.8% 0.48

Commodities 7.8% 8.4% 0.48

Volatility (VIX) 8.9% 6.3% 0.79

Data from 2/1990 to 6/2010


10078 Source: Bloomberg

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Real Estate Diversification
Increased interest rate sensitivity

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Geographical Diversification
Country versus Industrial Sector Concentration

United States New Zealand Brazil

Consumer Discretionary Consumer Staples Energy Financials Health Care


Industrials Information Technology Materials Telecommunications Utilities
Services
Data as of 7/31/2010
10078 Source: Bloomberg

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Natural Resource Diversification
Commodities, Contango, and Costs

December 31, 2005 to July 31, 2010


2.5

1.5

Index
0.5 Spot
Spot + Collateral

0
Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10

Data as of 7/31/2010
Source: Bloomberg
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Volatility Diversification
Trees-on-a-Lake Imagery

Data as of 7/31/2010
Source: Bloomberg
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Volatility Diversification
Buying “Insurance”

…but replicating VIX can be vexing


120

100

80

60
0
1
f$w
thG
ro

40
VIX--monthly % change

iPath S&P 500 VIX Mid-Term Futures


20 ETN (MKT)
iPath S&P 500 VIX Short-Term Futures
ETN (MKT)

0
Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10

Data as of 7/31/2010
Source: Bloomberg
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Asset Allocation: The Glide Path Debate
Summary
• “To” versus “Through” Design
– Governed by wealth level, among other factors (including age)
– Convex, “to” retirement paths best balance market and longevity risks
• Optimal Equity (Risk) Exposure
– Complex function of risk, return, time horizon, withdrawal rate, et. al.
– Sweet spot at retirement centers around 35% - 45%
– Higher risk is not an antidote to inadequate savings
• Effective Diversification
– Remains an investor’s best friend
– Not always a free lunch

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Thank you

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