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Retire Rich

By Lee Barney, MMExecutive

September 17, 2007

New Criticism of Lifecycle Funds Aims at Inflexibility

Lifecycle funds are now taking another punch, and while this one may not be fully merited, it is one that fund companies might want to consider as a roadmap to improving such funds' performance and marketability.

First, it was that lifecycle, or target-date, funds were too conservative in their equity/fixed income allocations and would not be able to provide retirees with adequate income to last as long as 20 or 30 years.

Fund companies responded, nearly unilaterally, by increasing U.S. and international equity holdings in target-date funds, even in income funds created specifically for those in retirement.

Then, apparently in their quest to differentiate their lifecycle funds from competitors and attract more assets, fund companies pushed the envelope even further and began packing them with alternative investments, such as real estate, commodities and emerging markets. This was met with yet another wave of spirited criticism, this time charging that lifecycle funds were becoming too risky.

Now a third wave of criticism has emerged, and to fund companies' credit, I'm not sure it's fully merited, although it is something they may want to take into consideration-particularly as a differentiating factor that fund companies can use to boost lifecycle funds' performance and position them differently from competitors.

According to a report from an investment strategy think tank called the Compass Institute, lifecycle funds are too inflexible because they adhere to projected market forecasts without taking economic developments and current market conditions into consideration. Now, that's not entirely true. Portfolio managers do oversee target-date funds and, typically, reallocate their portfolio holdings every quarter. However, perhaps target-date funds could be more actively managed and respond more nimbly to market conditions.

The Compass Institute studied the results of target-date and other formulaic asset allocation funds-such as balanced funds, managed accounts and funds that use Monte Carlo simulation-over the past 10 years and found that the worst-performing funds delivered average annual returns of 6.9%. On the high end, they rose an average of 8.8% a year.

By comparison, asset allocation funds with an adaptive mandate rose an average of 14.1% a year.

(c) 2007 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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Lee Barney

Lee Barney has been the editor of Money Management Executive since 2002 and has been writing about Wall Street since 1993. Previously, at United Media’s Wall Street & Technology magazine and Risk/Waters Information Services, she covered financial IT. For TheStreet.com, she wrote the daily “Meet the Street” column covering a broad spectrum of market-moving events. Lee began her career as a reporter in Tokyo with The Japan Times and was executive editor of Spotlight magazine.

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