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Wednesday, July 16, 2008

Target Date Funds...As I Was Saying

In my last post on July 10 I commented on the problems with target funds. An article in the July 13 NYT reinforced my points with some additional information. The pitfalls are particularly important because, as noted below, target date funds will be used as the “default option” for 401k participations that do not make asset allocation choices. And it is usually the case that only one fund family’s target date fund is offered (almost always that of the company administering the plan) locking the participant into a particular fee structure and allocation. More from the nyt below(my bolds)

“A new study has found a striking lack of consensus about how the funds should operate, leaving employees and retirees exposed to widely varying levels of risk. The fees that the funds charge vary widely, too.
Although target-date funds have won a special blessing from the government as a safe place for companies to put workers’ 401(k) money, the industry has no solid indexes or guidelines for assessing their performance. That means a worker who wanted to check on his target-date fund may have some difficulty assessing it. While research exists on various funds’ history, there is no accepted benchmark for comparison and no agreement on what constitutes success, wealth preservation or high returns.
Despite a lack of consensus about the funds, they have attracted a flood of money. ….
The study analyzed all 38 of the target-date funds on the market at the end of 2007. All of the funds offered younger workers a portfolio weighted toward stocks, gradually shifting toward a greater share of fixed-income instruments, like bonds, as the workers aged.

Beyond that, however, there was no agreement about how fast this shift should occur, or about the best asset allocation when a participant reached the all-important “target date,” usually assumed to be age 65. Some funds would be 65 percent invested in stocks on the target date, while the stock total for other funds might be just 10 percent. The funds also differed on what they expected investors to do with their money after their target dates.

The rate at which the funds changed their asset allocations over time — a crucial formulation known in the industry as a “glide path” — also varied greatly. Some funds’ glide paths were flat, others steep. The annual fees they charged ranged from 0.21 percent, the average charged by the Vanguard Group’s family of target-date funds, to 1.40 percent, the average charged by the Payden/Wilshire Longevity Funds family of funds.

Thursday, July 10, 2008

Target Date Funds: Do You Know What You Own ?

If good investing advice means knowing what you own then it seems the breathlessly enthusiastic report on target date funds in the current Business Week mystifies me. BW exclaims that:

Target-date mutual funds were supposed to lead a revolution in retirement savings. These funds, which automatically adjust their asset mix as an investor's retirement date approaches, were seen as a way for individual investors to achieve the discipline, diversity, and typically higher returns of pension funds. Now, 15 years after the first target-date fund launched, they are finally positioned to live up to their initial promise.
What took so long? One reason is that many funds didn't previously include the range of investments that have helped the traditional pension plan—that rapidly disappearing benefit—outperform the average 401(k) retirement savings plan. Commodities, emerging-markets stocks, and even private real estate are now being thrown into the mix”

In other words the mutual fund industry has been experimenting on your dime and you could have been investing for over a decade while the fund company figured out the “right” mix of assets. How one could have confidence that the funds are” ready to live up to their initial promise” is a mystery to me because the asset mix for funds with the same target date from different fund companies varies widely.
BW goes on:

“One key variable among the funds is the size of their equity stakes. Conventional wisdom once held that retirees should pare equities as they move into their 60s. But AllianceBernstein and T. Rowe Price argue that people need to invest more aggressively to make their nest eggs last longer. How much stock is enough? The typical pension fund is 65% invested in equities. A study by Watson Wyatt Worldwide shows that in target-date funds, equity allocations in the year of an investor's retirement range from 20% to 65%.”

Not only that, the fund companies have been changing their allocations within their target date funds:
International and emerging markets may be growing in your retirement portfolio, in a proportion sharply higher than when the funds opened:

“Target-date fund providers are also hiking their stakes in international equities. From 2005 to 2007 the international-equity weighting in these funds rose by as much as 7%, to a typical 17%. Managers say they want to capture a more accurate representation of global capital markets. T. Rowe Price broadened its international-equities position in target-date funds from 15% to 20% last November, beefing up investments in emerging markets such as Brazil, Russia, and China. “…

“Real estate holdings, another pension-fund staple, are popping up in more portfolios..


“Hedging strategies, long used in the institutional world, are also adding zest to target-date portfolios. Treasury inflation-protected securities (TIPS) and commodities have cropped up in a few target-date funds, including those offered by Fidelity and Principal Financial Group (PFG). Providers are mulling ways to invest in hedge funds and private equity, too.”

All the above leads one to wonder whether these are target date funds with a defined strategy for retirement savings or a license for the fund company to enter into whatever asset mix it sees as appropriate to maximize short term returns. What will these funds(and their investors) do if the investments in exotic emerging markets or commodities take a big tumble just as the target date approaches ? Are such volatile assets eliminated from the portfolio as the target date approaches ? I have yet to thoroughly research this issue but it seems that there are few explicit restrictions on the manager.
I wonder how much transparency is in these funds in terms of what they can hold, what their target allocations are and how often they can be changed. And it seems that there must be little in the way of tax management. What was peddled as a simple worry free form of retirement investing may be more of a potential problem than many investors think.
The Business Week article lists the % of Equity Holdings in the Target Date 2020 funds from several major fund companies. As you can see there is quite a range:
Alliance Bernstein: 80%
T Rowe Price 75.1%
Fidelity 69%
Vanguard 63%

Thursday, July 3, 2008

More Stories From The Bizarre World Of Hedge Funds

When Hedge Funds Bar the Door
Ritchie Capital Battles Investors,
Holds Tight to $2 Billion

From the WSJ July 2,2008
“Investors once clamored to get into Ritchie Capital Management, a high-profile hedge fund. Now, some are scrambling to get out -- and are finding the doors locked.
Following bad bets and big losses, A.R. Thane Ritchie has barred investors from leaving his fund, which is currently valued at $2 billion, down from almost $4 billion in 2005…..
The tussles illustrate the "roach motel" nature of hedge funds, where once investors get in, they can't always get out. Amid a continuing credit crunch, a growing number of hedge funds are restricting people from withdrawing their money for a period of time. Funds say they have no choice: To return the money, they'd have to sell off assets, leading to deeper losses for all their investors. But critics say locking down investors' stakes chiefly benefits fund managers, who get to keep earning hefty management fees.
Hedge funds were expected to be hit by requests from investors to withdraw their money at the end of June, after an especially tough second quarter. Analysts say it's too soon to determine the extent of these requests since it takes time for a fund to agree to them and then to raise money by selling off shares.
But with many funds invested in hard-to-sell, illiquid assets, some of those requests could be denied in the coming weeks -- and legal experts say a wave of litigation could follow. Limiting investors' withdrawals "has led to uneasy situations between managers and their investors, and frequently to the beginning of the end of the funds," says Leor Landa, a lawyer at Davis Polk & Wardwell who represents hedge funds.’

Ironically Ritchie’s stepfather one of the greatest options traders and founder of Chicago Research and Trading pulled his money out of Ritchie Capital Management’s funds in 2004 as the fund entered into more and more aggressive trading strategies.
It could be that the investment flows into hedge funds has peaked (see graph) as investors realize that there is no such thing as a low risk, positive alpha, absolute return strategy that will generate attractive returns in up and down markets.

Wednesday, July 2, 2008

Past Performance is No Guarantee of Future Results...One More Example

Fortune Magazine November 15, 2006:

“The greatest money manager of our time

What do ant colonies, novels and river systems have to do with making money? Ask Bill Miller, the man who's topped the market 15 years running. Fortune managing editor Andy Serwer reports. …

In case you haven't heard of him, Bill Miller is one of the greatest investors of our time. Refreshingly, he isn't some sort of billionaire hedge fund recluse. Miller runs an ordinary mutual fund, the $20 billion Legg Mason Value Trust, where he has produced extraordinary returns.
As it stands now, Miller has compiled one of the most remarkable records in the history of investing: His fund has outperformed the stock market for 15 straight years. That's right, 15 years, starting in 1991 - during George Bush the elder's presidency - through the tech bull market, then the crash and now the recovery.
That puts him in the same league as Peter Lynch, George Soros, even Warren Buffett. In recent years Miller has inadvertently added to the drama of his DiMaggio-like streak by falling behind in the first half, only to come roaring back in the fall and pass the market at the last minute. This year Miller's fund again got trounced by the market in the spring, and since then it has come back, only this time there's a difference. As of early November, Miller was still about 10 percentage points behind the S&P 500. So it is almost certain that he has too much ground to make up and that the streak will be broken. If you don't believe me, ask Miller: "It's unlikely I'll beat the market this year," he says, though he certainly thinks the condition will be temporary.”

Any reader of Naseem Taleeb’s brilliant book Fooled by Randomness would not be surprised by what came next:
Legg Mason Value Trust is = - 28.4% ytd through June 30,2008 underperforming the s+p 500 by 17.46%
3 year return is -8.52% (12.17% worse than the s+p 500)
5 year return is -.53% (8.03% worse than the s+p 500)