Target date funds criticized over risk

Equity allocations rise, but exposure varies widely among funds

May 5, 2008 @ 12:01 am

By Lisa Shidler

Target date mutual funds, long criticized for being too conservative to meet their goals, are now being taken to task for taking on too much risk.

At the end of December, the average target date fund had 68% of its assets invested in stocks, up dramatically from 55% five years earlier, according to a soon-to-be-released report from Financial Research Corp. of Boston.

That's too high, especially for investors on the verge of retiring, said Joe Nagengast, a principal in Turnstone Advisory Group LLC, a registered investment adviser in Marina del Rey, Calif.

"I don't understand the infatuation with high-equity allocations in target date funds," he said. "No matter what excuses are offered to justify it, they seem more like justifications for doing what they wanted to do anyway."

Target date fund managers are likely chasing performance, and that's why these funds have become filled with more equity, according to Joseph Masterson, a senior vice president at Purchase, N.Y.-based Diversified Investment Advisors Inc., which has $45 billion in assets under administration.

"I do caution that there's too much equity exposure for people who retire and the defined contribution plan assets are all of their assets in particular," he said.

In 2006 and early 2007, a number of fund managers, including The Vanguard Group Inc. of Malvern, Pa., and Boston-based Fidelity Investments, increased their equity exposure in their target date funds.

Critics say the firms bolstered equity in their funds to meet expectations for high returns. Proponents, however, contend that higher equity exposure is necessary to reduce the chances that retirees will outlive their money.

Target date funds offer investors a mix of stocks, bonds and cash, and the investments change as the investor's retirement age approaches. The closer the investor gets to retirement, the more conservative the fund's investments become.

Flows into target date funds grew 70% from 2006 to 2007, and assets reached about $182.5 billion at yearend, according to FRC. The boost in sales continues a five-year upswing, with assets increasing at least 60% each year since 2002.

Target date funds currently hold $184.5 billion. Net inflows into the funds totaled $14.9 billion during the first three months of the year, up slightly from $14.2 billion in the comparable period a year earlier, FRC said.

In 2000, there were 23 target date funds, according to Lipper Inc. of New York. Today, there are about 300.

A chief complaint with target date funds is that there is little standardization among them. For instance, Oppenheimer Transition 2010, offered by OppenheimerFunds Distributor Inc. of New York, has 75% of its assets invested in stocks, compared with 34% for Russell LifePoints 2010, offered by Russell Investments of Tacoma, Wash.

"It's like the Wild West out there at this point," said Don Stone, president of Plan Sponsor Advisors LLC in Chicago. "The disparity between equity exposures in these funds is huge."

"The other thing not being looked at is the risk within that equity exposure," said Mr. Stone, whose firm advises companies on their 401(k) plans.

"How diversified are you within that equity? How much of it is in international funds?" he asked.

D.J. Lucey, a senior analyst with Boston-based Cerulli Associates Inc. concurs.

"I think target date funds become problematic with volatility," he said. "There's varying degrees of equity and income products among the asset managers."

Thanks to the downturn in the stock market, higher stock allocations mean that many investors on the verge of retirement could be facing significant losses, Mr. Lucey added.


Indeed, a prolonged downturn may prompt some fund companies to lower their target date funds' exposure to stocks, said Lynette DeWitt, an analyst with FRC.

"If there is a retreat from higher-equity allocations in target date funds, it will occur over time and be in response to a prolonged market downturn, not one of just a few months," she said.

The industry as a whole has shifted too far into equity exposure recently, according to officials at San Francisco-based Wells Fargo & Co., who have maintained a conservative stance.

The Wells Fargo Advantage Dow Jones Target 2010 contains 21% equities and a fund for retirees contains just 18% in equities. The firm has $2.6 billion in target date fund assets.

"In my view, these things swing back and forth in terms of what the experts are saying — whether you should be more or less aggressive," said Christian Chan, vice president of investments.

"Our view is, you should be aggressive when you have a long time horizon."

Matt Smith, managing director for retirement services at Russell Investments, agrees. "If you experience a bad investment return at 63, you don't have a chance to make up for those returns," he said.

Of course, not everyone backs that viewpoint.

"We found you get more downside protection with equities," said Jerome Clark, portfolio manager of Baltimore-based T. Rowe Price Group Inc.'s retirement funds.

"The caveat is, it's over longer time periods. We concluded that the biggest risk is outliving your assets," he said.

No matter what, the fund industry is clearly torn on how much equity should go into target date funds, said John Ameriks, a senior investment analyst with Vanguard.

"People are trying to look for the right answer," he said. "I think there's a healthy debate around this issue."

E-mail Lisa Shidler at


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