Global assets retreat amid heightened uncertainty

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Q1 2022 Putnam Retirement Advantage Trusts Q&A

• Global equities and fixed income posted losses due to geopolitical uncertainty, persistently high inflation, and rising rates.
• We are refraining from a bearish position to equities given slightly bullish signals from our quantitative model, strong economic data, and the Fed's aggressive efforts to tackle inflation.
• We believe our investment strategies give us the ability to adapt the portfolio to changing market conditions.

How were market conditions in the first quarter?

It was a challenging quarter for global financial markets amid increasing headwinds. The Russian invasion of Ukraine, hawkish comments from the Federal Reserve, and persistently high inflation sent equity markets lower. Stocks rebounded slightly in March when the Fed lifted the federal funds rate to a range of 0.25% to 0.50%. Investors viewed this interest-rate hike as a positive step by the Fed to combat inflation. Peace talks between Ukraine and Russia later helped stocks move slightly higher, but not enough to erase earlier losses. The S&P 500 Index returned –4.60%. International stocks, as measured by the MSCI EAFE Index, posted a return of –5.91%.

Bond markets also experienced significant declines over the quarter. Following the Fed's rate hike in March, Fed policymakers penciled in six more increases by year-end, reduced their U.S. growth estimates for 2022, and raised their inflation expectations. The Fed's median projections show their benchmark interest rate rising to a range of 2.50% to 2.75% by the end of 2022. This would be the highest level since 2008.

At times, yields on some shorter-term U.S. Treasuries, such as the 2-year note, edged above those of longer-term Treasuries. This created a flat or inverted yield curve. By quarter-end, the yield on the 2-year Treasury note had climbed from 0.73% on December 31, 2021, to 2.28% on March 31, 2022. The yield on the benchmark 10-year Treasury note rose from 1.52% to 2.32% for the same period. The Bloomberg U.S. Aggregate Bond Index, which is largely composed of Treasuries, highly rated corporate bonds, and mortgage-backed securities, returned –5.93% for the quarter.

What role did the glide path play in performance?

The glide path of Retirement Advantage strategies is an important feature that distinguishes Putnam from its peers. Our glide path is more aggressive early on. It has a higher stock market weight than the average for our peer group for funds serving people retiring in the 2060s. Our glide path becomes more conservative relative to peers for funds serving investors nearing retirement in the 2020s. With both global equity and global fixed income markets suffering declines, longer-dated strategies and more fixed income-oriented portfolios near retirement finished with similar losses.

Longer-dated portfolio losses were a product of their higher equity allocations and the sell-off experienced by risky assets during the quarter. Shorter-dated strategies were still impacted by this move lower but were also impacted by bond market weakness as interest rates rose sharply during the quarter.

What strategies affected performance?

Overall, our asset allocation decisions aided benchmark-relative performance. The portfolios gained most from equity positioning during the quarter. The equity position ranged from modestly overweight to modestly underweight before we moved the position to neutral toward the end of March. Our modest underweight position to interest-rate risk slightly benefited the portfolios. We moved the position to neutral at the beginning of February. An out-of-benchmark, long position to commodity risk, implemented at the beginning of March, led to a small gain. Credit positioning did not have a significant impact on performance. Overall, we have been more active in adjusting our asset allocation positions, seeking to take advantage of volatility across stock, bond, and commodity markets.

Security selection was slightly additive relative to the benchmark for most portfolios. Our fundamental U.S. large-cap value equity, quantitative U.S. large-cap equity, and opportunistic fixed income strategies ended slightly positive. Security selection was roughly flat in portfolios furthest from retirement, with gains from strategies mentioned above offset by weakness from our fundamental emerging market equity strategy.

What is your near-term outlook for the markets?

The first few months of 2022 saw significant volatility. Rising inflation, supply chain disruptions, monetary tightening, and Russia's invasion of Ukraine fueled sell-offs in stocks and bonds. Looking ahead, we expect volatility to persist and market sentiment to waver as these issues continue to plague markets with no clear resolutions in sight.

Our current outlook on equities is neutral. The stock market presently faces major headwinds, including a slowdown in earnings growth, rising interest rates, and geopolitical tensions in Ukraine. However, we are refraining from a bearish position given slightly bullish signals from our quantitative model, strong economic data, and the Fed's aggressive efforts to tackle inflation.

In fixed income, our view on credit is modestly bearish. Assuming we have moved beyond the pandemic, it's likely that the United States emerges very close to where it was in the credit cycle in late 2019 before the pandemic began. We also believe the high-yield index has reached peak credit quality and is not likely to improve from here. Our outlook on rate-sensitive fixed income is neutral. Yields have moved higher due to a significant and possibly overdone shift in Fed expectations, in our view. At the end of 2021, markets had priced in three interest-rate hikes for 2022. By quarter-end, the Fed had raised rates by a quarter of a percentage point, and markets had priced in six additional rate hikes for 2022. We expect a balanced distribution of outcomes moving forward.

Against this backdrop, we continue to have conviction in our investment strategies given our ability to adapt the portfolio to changing market conditions.