Equity strength drives funds' positive absolute returns

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Q2 2023 Putnam Retirement Advantage Funds Q&A

• All Retirement Advantage vintages delivered positive absolute returns in the quarter, driven primarily by equity market strength.
• Security selection decisions boosted the funds' benchmark-relative performance.
• The Fed paused interest-rate hikes in June, but tighter-than-expected monetary policy could increase yields in the near term.

How were market conditions in the second quarter of calendar 2023?

Stocks proved resilient against numerous headwinds over the quarter. Persistent inflation, a U.S. banking crisis, decelerating growth in China, and uncertainty over the trajectory of monetary tightening kept volatility elevated.

Following several U.S. regional bank failures in March 2023, concern around the stability of the banking sector continued into the second quarter. Fortunately, quick actions by global central banks to minimize systemic risk helped calm investors' nerves. Better-than-expected corporate earnings, driven by strength in the technology, consumer discretionary, and health care sectors, also improved investor sentiment.

With inflation moderating but still high, the U.S. Federal Reserve raised interest rates by 0.25% in May. This brought the federal funds rate to a range of 5.00%–5.25%, its highest since 2007. At its June meeting, the Fed voted to pause rate hikes to assess the full impact of its monetary tightening on the economy. Also in June, a bipartisan resolution to the U.S. debt ceiling debate was signed into law. This prevented a default, which further lifted stocks.

U.S. stocks, as measured by the S&P 500 Index, returned 8.74% for the quarter ended June 30, 2023. Non-U.S. stocks in developed markets returned 2.95%, as measured by the MSCI EAFE Index [ND]. Underperformance relative to U.S. stocks was attributed to negative GDP [gross domestic product] in the eurozone economy. Emerging market stocks, as measured by the MSCI Emerging Markets Index [ND], returned 0.90% for the quarter. A slowdown in China's housing market and stagnant consumer spending dampened investors' outlook for emerging market economies.

As risk appetite improved over the quarter, high-yield bonds outperformed investment-grade bonds. The JPMorgan Developed High Yield Index returned 1.86%, while the Bloomberg U.S. Aggregate Bond Index returned –0.84% for the three months ended June 30, 2023. The yield on the 10-year U.S. Treasury note began the quarter at 3.48% and ended at 3.84%. The yield curve remained inverted, which reflects investors' expectations for a decline in long-term interest rates. [The yield curve is a graphical representation of the yields/interest rates of bonds with equal credit quality but differing maturity dates.]

How did Putnam Retirement Advantage Trusts perform during the three months ended June 30, 2023?

All Retirement Advantage vintages delivered positive absolute returns. Gains for the longer-dated portfolios were a result of their higher equity allocations and strength across global equity markets. Shorter-dated fixed income-oriented strategies also benefited from this move higher in equities but finished with smaller positive returns, as fixed income underperformed equities.

Putnam Retirement Advantage Trusts invest in underlying Putnam collective investment trusts to create a diversified target-date portfolio. We use an important tool called a glide path to determine the funds' allocations among asset classes and the underlying funds over time. With the glide path as a reference point, our portfolio managers make tactical decisions based on our analysis of current market risks and opportunities.

What strategies contributed to and detracted from performance?

Asset allocation decisions detracted from benchmark-relative performance. We entered the period with an underweight position to equity risk and maintained this position. This weighed on performance, as equities experienced strength. With respect to commodity risk, the portfolios maintained a neutral position throughout the quarter. The portfolios entered the period neutral with respect to interest-rate risk. In mid-June, we shifted the position to modestly underweight. This tactical positioning within interest-rate risk led to a gain over the period.

Overall, our security selection decisions boosted benchmark-relative performance. Our quantitative U.S. large-cap core, fundamental U.S. large-cap growth, and fundamental U.S. large-cap value equity strategies enhanced performance. Vintages further from their retirement target date also benefited from our fundamental emerging market equity strategy.

What is your near-term outlook for the markets?

We expect elevated inflation, tighter financial conditions, and recession fears will continue to weigh on market sentiment for the foreseeable future.

Our near-term outlook for equities is bearish. We believe the Fed is unlikely to execute a soft landing and will either maintain interest rates at higher levels than the market anticipates or disrupt the economy and trigger a recession. Both paths would prove negative for equities, in our view.

Our near-term outlook for interest-rate-sensitive fixed income is slightly bearish. We expect tighter-than-expected monetary policy to increase yields in the near term. Recent economic data releases have remained robust enough to allow the Fed to continue its hiking cycle. If its June dot plot is to be believed, current expectations are not hawkish enough. With core inflation still elevated, the job market still tight, and other central banks around the world resuming hikes after having paused, it seems markets are underestimating the Fed's resolve.

Our view on commodities is neutral. Many physical markets remain tight, but escalating potential for recession from recent crises and tightening financial conditions are downside risks, in our view. Commodity volatility has also increased significantly.

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