Target date funds set to surpass $1T by 2012

Target date mutual funds are on track to amass $1.1 trillion in assets by 2012, up from about $277 billion today, according to a recent report from Cerulli Associates Inc.

Much of that growth will come as target date funds continue to gain traction among defined contribution plans, according to the report.

“In the current post-Pension Protection Act of 2006 era and with clarity from agencies on qualified default investment alternative inclusions and exclusions, these funds are poised to grow rapidly,” the report said.

The Pension Protection Act of 2006 endorsed automatic enrollment of employees in defined contribution plans, allowing three default options: target date funds, balanced funds and managed accounts. As a result, many companies have stepped up demand for target date funds.

Currently, target date funds represent only about 6% of total defined contribution assets. But about 50% of new money flowing into defined contribution plans is making its way into target date funds, the report said.

“There’s going to be strong growth,” said D.J. Lucey, an analyst at Boston-based Cerulli. “I see a lot of evolution in these products. I think there’s room to improve what the underlying asset allocation is and what it means for the participants.” That’s where advisers need to be to help, he said.

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.

APPROACHES VARY

A chief complaint with target date funds is that there is little standardization among them.

“There are a pretty wide variety of approaches to target date funds,” Mr. Lucey said. “This is both interesting and potentially scary. I think many participants aren’t aware of the underlying asset allocation.”

Even advisers who recommend target date funds in retirement accounts recognize their limitations, said Stace A. Hilbrant, managing director and an investment adviser representative with 401(k) Advisors LLC of Wilmette, Ill., which manages about $900 million in assets and oversees 75 retirement plans.

“I’m very critical about target date funds,” said Mr. Hilbrant, who said many of his corporate clients use target date funds. “I’ve been a big fan of creating customized portfolios.”

Mr. Hilbrant believes that advisers will continue to take underlying funds of 401(k)s plans and create customized target date funds.

Employers are also beginning to understand that target date funds have varying degrees of equity exposure, said Doug Prince, an Indianapolis-based adviser with Stifel Nicolaus & Co. Inc. of St. Louis, which manages about $2 billion in assets.

Some employers have rejected particular target date funds because they felt that the exposure to stocks was too high, he said.

“I think what’s developing is, the industry is beginning to figure out how to analyze these better,” Mr. Prince said. “I don’t think the tools were out there, and we’re starting to get a better handle of how to look at these vehicles better.”

Another potential problem with target date funds is that some employees may be planning to withdraw a significant chunk of assets as soon as they hit retirement.

“If someone is planning to use a substantial part of that balance for an immediate liquidity lead, they’ll be exposed to asset classes that they’re not expecting,” Mr. Lucey said.

E-mail Lisa Shidler at [email protected].