2011: Another year of target-date disappointment

BOSTON (AP) ? Another tough year in the markets, another setback on the road to a financially secure retirement.

Investment portfolio balances are healthier than they were three years ago during the worst of the financial crisis. But doubts about a full recovery linger, after most target-date mutual funds ended 2011 with losses.

By design, these set-it-and-forget-it funds are supposed to calm investor nerves. Increasingly popular in 401(k) plans, they automatically adjust to fewer stock holdings and more bonds as workers approach the target year when they hope to retire.

But that goal seems a bit more distant. Eight of the nine target-date categories that Morningstar tracks lost money in 2011, based on average fund performance in those groups. Losses ranged from an average 0.2 percent for funds with the target year 2020, to 4.1 percent funds intended for young investors eyeing retirement in 2050 or beyond.

It’s important to keep perspective. Investors in those 2020 funds still have around eight years or so to make up for their small 2011 setback. And the losses weren’t nearly as painful as those in the stock market meltdown of 2008. That year, funds with a target date of 2010 ? with just two years to potentially recover ? lost an average 25 percent.

Nevertheless, last year’s losses are disappointing, because they came in a year when the Standard & Poor’s 500 index ended virtually unchanged, but returned 2.1 percent including dividends. And bonds rallied. A broad measure of that market, the Barclays Capital U.S. Aggregate Bond index, returned 7.8 percent.

Target-date fund investors opening their annual statements may be asking themselves: Why did I end up with a loss when the major indexes finished a few percentage points higher?

One reason is that investors shouldn’t overlook fees. Target-date funds typically charge around 1 percent of assets to cover operations, so investors should expect their returns will fall slightly short of market performance.

A more important reason is that many target-date fund portfolios have evolved, for better or worse, beyond their initial relative simplicity.

When first launched in the 1990s, the portfolios invested almost exclusively in U.S. stocks and bonds. Those investments remain the foundation of target-date portfolios, but many have expanded into international stocks.

And in many instances, stocks and bonds are just a part of the mix. These days, it’s not unusual to see 5 to 10 percent of a target-date portfolio in alternatives investments, such as commodities and real estate, with a goal of spreading risk across many types of assets.

That increasing diversification hindered target-date performance in 2011. For example, the U.S. stock market performed far better than foreign markets, as U.S. economic prospects improved relative to the outlooks in many other countries. An index of foreign developed countries lost about 12 percent, while emerging markets stocks fared even worse. A commodities index fell 13 percent.

Because many target-date portfolios are so diverse, it’s not entirely fair to measure their performance against those of the key U.S. market indexes, says Josh Charlson, a target-date fund analyst with Morningstar.

“If you believe in diversification, and in access to all areas of the market, then you might say, ‘I’ll take some losses in a year like 2011, to get that broader exposure over the long-term,'” Charlson says.

That’s because he says it’s important to remember that a target-date portfolio with significant international holdings and some alternative investments may outperform a more basic U.S. stock-and-bond portfolio over periods of several years, while also lowering overall volatility.

But 2011was a year when it paid off to invest in bonds, and take a conservative approach, says Brooks Herman, of investment researcher BrightScope Inc.

The general trend among target-date funds since the financial crisis has been to limit their exposure to the stock market. For example, three years ago, funds projected holding an average 43 percent of their portfolio in stocks at an investor’s retirement date. Now, the average is about 40 percent, according to a study by Lipper Inc. last month.

The decreased allocation to stocks should have helped target-date funds last year, because bonds outperformed stocks.

Lipper analyst Sasha Franger isn’t expecting wholesale changes in target-date portfolio design based on the funds’ spotty performance in recent years. She notes that the 2011 losses were small compared with the sharp declines experienced in 2008, when the industry came under scrutiny that included congressional hearings.

Target-dates ? also known as lifecycle funds ? continue to attract investors. They hold about $369 billion in assets, more than double the total three years earlier. Last year, target-date funds attracted $1.6 billion in net deposits, according to Morningstar.

One reason for the funds’ popularity: They’re often the default option for 401(k) enrollees who don’t specify how to invest money set aside from their paychecks.

But the funds continue to be widely misunderstood, especially among investors who’ve already reached retirement, Franger says.

Many fund companies have improved their disclosures since the financial crisis, but a couple of messages bear repeating: As with any investment, there’s no guarantee target-date funds will rise in value. And returns are likely to fall short of the markets the funds invest in, whether because of fees, poor investment selection, or both.

“There will be years with losses, and years when they don’t perform as well as the S&P 500,” Franger says. “They’re risky, and investors need to understand them.”


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