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.

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. “…

AND

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

“

AND

“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%

More Stories From The Bizarre World Of Hedge Funds

LOCKED IN
When Hedge Funds Bar the Door
Ritchie Capital Battles Investors,
Holds Tight to $2 BillionBy SUSAN PULLIAM



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.

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)

Morningstar Doesn’t Think You Can Figure Out Investing

Indexuniverse.com reports:

“Don Phillips, Morningstar's director of corporate strategy, research and communications, told JoAnne Von Alroth of Investor's Business Daily that ETFs will never replace mutual funds.

He said: "It's natural that over time portfolios become more sophisticated, but I don't think most people have the time to get the diversity exclusively from ETFs that they can get in mutual funds. The traditional open-end mutual fund will continue to be the building block of most people's portfolio."

They must think most folk are stupid and not capable of comprehending the results of this morningstar study reported in an excellent WSJ article entitled “As Returns Sag,Investors Focus On Fees”

“After falling substantially between 2003 and 2006, the expense ratio paid by the average investor in retail mutual funds stayed level last year, at 0.9%, according to a recent study by fund-tracker Morningstar Inc”…..
…other recent developments could mean higher fees for many fund investors in the coming years. For one, investors concerned about the U.S. economy and the dollar are putting more money in foreign funds. These tend to carry higher fees than domestic funds.”

figure a basic investor could either create a portfolio of just 3 etfs from vanguard: total bond mkt index(mgmt fee.11%), total ex us international index(.25%mgmt fee), and total us index(.07% mgmt fee) and create a decently diversified portfolio with mgmt fees. That means just a little bit of effort by an investor could reduce his investment fees by more than 75% and arguably offer more diversification . Or higher an objective advisor(like me) that will steer you the right way with a more sophisticated low cost etf strategy
Of course it couldn’t be that Morningstar, which makes most of its money from selling research on actively managed mtual funds and selling advertising space to managers of actively managed mutual funds (take a look at the glitz add from a fund country that hits you before you even get to the content at morningstar.com) , has a little bit of a bias on this issue…or could it ?

Investing Seminar: Everything Your Broker (most likely) Is Not Telling You About Your Investments

I am giving monthly seminars in the Los Angeles area. The next one is July 1 4:30 -6 in Century City

rsvp to lweinman@keeleradvisors.com

Target Date Funds..A Good Idea to Look Under the Hood

I am not a big fan of target date funds since they give the investor little control over the content of their portfolio, how rebalancing is implemented and tax management. Also there is often little transparency. In my view most investors are better off constructing their own investment portfoilo by themselves or with an advisor that gives them individualized advice.

So I was not surprised to find the following in Investment News a financial industry publication. Apparently the interpretation of what the appropriate target date allocation consists of differs massively between fund companies….and it seems to be a moving target my bolds, my comments in italics

Target date funds increase equity exposure
Equities average 68% of portfolios, up from 55% in 2003, new study from FRC finds
By Lisa Shidler
June 16, 2008
“Managers of target date funds have increased their allocations to equities, on average, but some of the funds' specific investment strategies are difficult to discern, a new study from Financial Research Corp. has found. …..
…"We reviewed their prospectuses and we found that as a general rule we could find the basic features of target date asset allocation strategies in the fund prospectuses," said Lynette DeWitt, a research director with Boston-based FRC.
"However, there were cases where data [were] missing," she said. "It was difficult for us to compare one strategy against another."
“One strategy was clear: increasing equity exposure. The report found that 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. “ Does that mean these folk have changed their view of the proper allocation, how much disclosure to current and future investors have they given about this ?This is certainly disturbing….funds with the same target date can have quite different allocations:But the disparities among funds are marked. For example, Wells Fargo Advantage Dow Jones 2020 fund had 51% equity exposure, while Fidelity Freedom Fund 2020 had 69% equity exposure and Oppenheimer Transition 2020 had 90% of its assets in equities.
And this is faint praise imo:

“While target date funds may not make much sense for high-net-worth clients, 401(k) participants who lack investment expertise may find them useful, said Lisa Falcone, a financial adviser with Newton, Mass.-based Sapers & Wallack Inc., which manages $200 million in assets.
"If you have no investment knowledge whatsoever and you're not comfortable picking funds and don't want to be bothered, then target funds are the way to go," she said. “
In other words if you are clueless and have no desire to increase your knowledge or hire an advisor to help you with one of the most important decisions in your life then unlike wealthier folk you should go ahead with one of these funds
I actually agree with these comments by the same advisor although I don’t think it means that these funds are a good choice for anyone:
“Ms. Falcone also worries that many of these funds don't make their investment choices easily discernable.
"It's just not as transparent as other mutual funds where I can see everything," she said.
And this retirement plan administrator seems to agree that they are not a particularly attractive choice even withing 401ks:
"In a typical target date fund, you really don't know what the makeup is," said Joseph Masterson, a senior vice president at Purchase, N.Y.-based Diversified Investment Advisors Inc., which administers retirement plans having $43.2 billion in assets as of yearend 2007