From the April 2008 issue of Boomer Market Advisor • Subscribe!

Focus on outcome

As the leading edge of baby boomers march ever closer to retirement age, the nature of the products they seek to fill their financial planning needs is undergoing a steady transformation.

What we see is an increasing demand for outcome-oriented financial products. In contrast to prior product demand, when investors and their advisors looked at mutual fund offerings as being one-dimensional, today's marketplace demands more multi-dimensional products to solve complex financial planning needs.

Outcome-oriented funds combine investments in multiple asset classes, generally with low correlation among them, to help reduce the level of volatility inherent in investments in a single asset class. Early forms of this type of product included asset allocation funds that are prevalent in defined contribution plans.

More recent developments have extended the strategy to solve more specific investor needs, particularly as they relate to adequate income in retirement and building a retirement portfolio that can withstand inflation.

This is a natural evolution, as investors are increasingly responsible for their own retirements. This shift was highlighted in MFS research on the retirement planning concerns of affluent pre-retirees, retirees and their advisors. The research shows that 40 percent of those in retirement cite a traditional pension as the primary source of income in retirement, compared with only 23 percent of pre-retirees. Defined contribution plans such as 401(k)s, by contrast, are cited as the primary source by 25 percent of pre-retirees compared to only 11 percent of those already in retirement.

Other findings highlight investor concerns about having adequate income in retirement and the long term impacts of inflation on a retirement portfolio. These concerns point to a need for outcome-oriented funds that can help investors achieve growth of income throughout their retirements, and to provide a return that outpaces inflation and does not incur excess market volatility.

The old paradigm said, "Stocks for growth, bonds for income." But as fixed-rate instruments, bonds pay a level of income that cannot keep up with inflation over the long term. And increasing life expectancies means that the risk of inflation is significant.

Outcome-oriented funds seek to solve this dilemma by combining fixed-income asset classes that produce current income (such as corporate and government bonds and emerging market debt) with income producing equity asset classes, such as dividend-paying stocks and real estate investment trusts, that can grow income over time. Low correlation among the underlying asset classes also helps to smooth out volatility and provide a level of price stability.

The MFS research found that inflation was the number two concern of both pre-retirees and retirees relative to their retirement income plans, second only to unforeseen health expenses. And any discussion of health expenditures comes back to the topic of inflation.

This suggests a keen interest among investors for products that can provide a target rate of return that will exceed inflation over time, without incurring a substantial amount of market volatility. Outcome-oriented funds can seek to address this concern by targeting a reasonable rate of return and constructing well diversified portfolios to achieve that return with an acceptable rate of volatility. Portfolio overlay strategies can help actively manage a fund's market and currency exposures through the use of derivatives. MFS recently introduced a product in this vein, called the MFS Diversified Target Return Fund.

The ability to combine non-correlated asset classes in a single product can yield substantial benefits. Prior generations of retirees were more likely to rely on pension trustees to construct such portfolios. As current and future generations of retirees accept more responsibility for their own retirements, such outcome-oriented funds can be critical in helping them achieve a comfortable retirement.

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