Lock ‘n’ load: Taking target funds tactical

A handful of big fund companies are revamping their target date offerings in hopes of limiting risk — and preventing another major blowup.

Against the backdrop of consumer outrage over huge losses in target date portfolios, a handful of big fund companies are revamping their target date offerings in hopes of limiting risk — and preventing another major blowup.

AllianceBernstein LP, Van Kampen Funds Inc., Invesco Ltd. and Putnam Investments have all announced changes to their target date portfolios that will enable managers to provide more active management.

In some cases, the funds now will allow managers to move in and out of different asset classes more quickly during market fluctuations. Others are adding funds to their target date portfolios that are meant to protect investors from market downturns.

Lawmakers and fund providers have been looking for ways to lower risks in target date funds after 2010 funds lost an average of 25% in 2008. Most of the scrutiny has been on the glide paths of these short-horizon funds — those for people nearing retirement — for having stock-heavy allocations, rather than more conservative bond holdings.

About $245.2 billion in assets is held in target date funds, according to Morningstar Inc.

Meanwhile, the Labor Department is planning to issue guidance on how plan sponsors would be allowed to use target date funds in their defined-contribution plans soon.

Most defined-contribution participants are automatically enrolled in target date funds.

Separately, Sen. Herb Kohl, D-Wis., is working on proposed legislation that would mandate that target date fund managers take on fiduciary responsibility under the Em-ployee Retirement Income Security Act of 1974.

“Most firms we talk to are looking at this and trying to figure out how to do it [limit risk in their target date funds],” said Lynette DeWitt, a research director at Financial Research Corp. “They are trying to get prepared because they believe that we are going to have faster market fluctuations than we have had in the past.”

Managers should have more flexibility in how they invest target date funds, said Marcia Wagner, founder and principal of The Wagner Law Group. “The way the old target date funds worked, there was very little flexibility and there was an overconcentration in equities.”

But adding a layer of tactical asset allocation to these funds does not guarantee less volatility, industry experts say.

“If you can do it, well, that’s great. But I think it’s very hard to do,” said Stephen Sexauer, chief investment officer at Allianz Global Investors Solutions, which has no plans to change the way it manages its target date funds.

Allowing fund managers greater flexibility could make it more difficult for investors to see where their money is being invested.

“I think the higher the tactical budget, the less transparency there is going to be,” said Laura Lutton, an analyst at Morningstar. “In most cases you don’t have a record that can point to what is in these strategies.”

Other critics point out that this emerging trend is an admission by target date fund managers that their original premise didn’t work.

“If you had a chance of investing in a fund that acknowledges that it’s too risky — so it has to layer on a strategy to hedge the risk — would not you find one that doesn’t have as much risk to start out with?” asked Joe Nagengast, a principal with Target Date Analytics and president of Turnstone Advisory Group.

Starting next month, AllianceBernstein will allocate up to 20% of funds in its target date portfolios to a “volatility management component.” During normal markets, those funds would be invested in a mix of equities and real estate investment trusts, but in a downturn, the assets can be shifted to bonds and cash to reduce overall portfolio risk, said Thomas J. Fontaine, head of defined contribution.

“This hopefully addresses many of the concerns [about target date funds] that came out of 2008,” he said.

On Feb. 5, Van Kampen filed supplemental documentation with the Securities and Exchange Commission broadening the target allocations for the different asset classes in the 10 Van Kampen Retirement Strategies funds. Previously, the target allocations were expressed in specific targets, but now they will be expressed in ranges, according to the filings.

For example, previously the Van Kampen 2010 Retirement Strategy Fund had a stated target allocation of 46% to equities, 51% to fixed income and cash and 3% to alternative investments. Now, the fund’s prospectus will state that its equity target will range from 25% to 50%; with 50% to 75% for fixed income and 0% to 10% in alternative investment funds, according to the filing.

Invesco Ltd., which recently bought Van Kampen, recently made similar changes to its Aim target date funds. Instead of using a mix of Aim mutual funds and Invesco PowerShares exchange-traded funds as the underlying assets in its target date funds, the firm made the Aim Balanced-Risk Allocation Fund a key component of the portfolios, said Scott Wolle, chief investment officer for global asset allocation.

“The appeal of the balanced-risk allocation fund is that it is specifically designed to limit any downturns,” Mr. Wolle said. At the same time, Invesco also started re-balancing its funds on a monthly basis rather than annually.

Putnam was one of the first firms to revamp its target date funds.

In response to the market crash of 2008, the firm in September incorporated its Absolute Return funds as underlying portfolios within the target date funds to provide more downside protection, said Jeffrey Knight, head of global asset allocation at Putnam.

Not everyone believes that tweaking target date funds is the answer.

“People are being too short-term- focused about target date funds,” said Keith Hartstein, president of John Hancock Funds LLC, which last month filed with the SEC to launch a new series of target date fund using more passive investments.

Mr. Hartstein said he was worried the industry was overreacting to the market crash by becoming too conservative. “What is going to happen when people don’t have enough savings when they retire?” he asked. “Will Congress be there then?”

E-mail Jessica Toonkel Marquez at [email protected].