Some Improvement in Target Funds...But I'm Still Not A fan

I have written several times about the problems with target date funds. The dismal performance and the large differences between the performance of funds with identical target dates provided quite a surprise for investors who perceived these as a safe and conservative investment vehicle.

It seems the fund companies are looking to rework these funds as well indicating they weren't ready for prime time when they came to market. And what is the revolutionary idea that these fund companies are coming up with ?.....more use of low cost index instruments. The funds still have many problems with regards to transparency of the "glide path" (the way the allocation changes as the target date approaches) and how they fit into an overall investment strategy. Seems to me that most investors are far better off with their own portfolio of low cost index instruments,

The FT today on changes in the target funds. My bolds my italics

Steep losses fuel growth of passive investing

By Marianna Lemann

Published: October 4 2009 10:07 | Last updated: October 4 2009 10:07

The long-running debate over active versus passive management has emerged in the target date fund market, where a number of active managers are turning to passive strategies.

Most notably, Fidelity Investments, the number one provider of target date funds in the US by assets, recently disclosed in regulatory filings that it is planning to offer an index fund version of its target date series, known as the Freedom Funds.

Fidelity is not alone. TIAA-Cref is also about to roll out an index version of its target date fund series and Schwab has boosted its allocations to index funds held within its target date series.

Meanwhile, Morningstar reports that firms like Seligman, Nationwide, State Farm, Barclays, AIM and DWS have more than 30 per cent of target date fund assets invested in passive strategies.

The growth of passive investing in target date funds comes as steep losses have fuelled scepticism about the value of active management within the funds....

Last year’s market turmoil revealed that many target date funds had a more aggressive allocation (known as the glide path) than investors may have expected, with many 2010 target date funds suffering double-digit losses. Those losses drove investors, plan sponsors and regulators to take a closer look at how these funds are structured, managed, priced and marketed.

As part of that review, cost has become a bigger issue across the mutual fund industry and is taking strong root in the target date marketplace, says Josh Charlson, a senior mutual fund analyst at Morningstar....


“The new funds will expand the products we offer our clients to help them create the best possible retirement-plan menu for their employees,” Ms Cohen says. “We believe active and passive target date funds offer clients important advantages – strong diversification and automatic rebalancing, in a convenient package.”

The lower expense ratios are also important, says Mr Charlson of Morningstar. Active management erodes performance by virtue of higher fees and adds an extra layer of risk to target date funds.

“In 2008 it became evident that even with a glide path you could end up with losses beyond what you might expect because of a blow-up in a core bond fund,” he says.

In fact, the Standard & Poor’s index versus active fund scorecard (Spiva) suggests the higher fees investors pay for active management generally do not result in better returns. The latest Spiva scorecard, which covers a five-year period ending June 30, shows the S&P 500 outperformed 62.9 per cent of actively managed large cap funds, 73.4 per cent of mid cap funds and 57.4 per cent of small cap funds.

“There is a trend towards indexing or passive investing in the target date space and it makes sense because target date funds are part of a long-term financial plan, generally encompass a large portion of an investor’s assets and have a long time horizon,” says Doug Dannemiller, a senior analyst with Aite Group. “You don’t need alpha to satisfy that goal, you can’t plan for alpha but you can plan for cost savings.”



“I wouldn’t be surprised to see a lot of firms having multiple target date offerings,” says Laura Pavlenko Lutton, editorial director at Morningstar’s mutual fund research group.

Of course morningstar with its vested interest in serving the interests of active mutual fund managers and creating a market for the analysis of such funds sees the perfect world as one of endless complications and high fees for investors::

“Maybe you’d have one with a conservative glide path or a more aggressive glide path or all index option or all active option. We are going to see a lot more niche target date offerings that have more of a specific mandate rather than being for everyman.”