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Target-Date Funds Gaining More Favor


CAMBRIDGE, Mass.-Target-date funds will continue to increase in popularity due to their simplicity, automatic rebalancing and diversification, according to panelists at Financial Research Associates' "Target Date Lifecycle Funds" conference here last week.

Assets in target-date funds are now $145 billion, up 32% from $110 billion last year, according to data from Financial Research Corp. of Boston. And over the next five years, assets are expected to grow at an annual rate of 26%. Last year, fund companies introduced 302 new lifecycle funds, according to data from Morningstar.

Forty-four percent of the 830 plan sponsor respondents to Deloitte Consulting's annual 401(k) benchmarking survey offer time-based funds, up from 28% last year.

"We all have different philosophies on how target-date funds should be implemented, but we do agree that it is a better option for investors than what we have had in the past," said John Sturiale, vice president and portfolio manager at San Francisco-based Charles Schwab.

When designing a target-date fund, companies need to consider the asset allocation "glidepath" determination. The glidepath is how quickly a fund moves from stocks to bonds, and each company has their own philosophy and mathematical equation on how to arrive at that glidepath.

Also, firms need to decide whether the fund should be managed actively or passively, panelists agreed.

The active or passive style is important, but secondary, said Jerome Clark, vice president and portfolio manager in the asset allocation group at T. Rowe Price of Baltimore, adding that "the big focus needs to be on the glidepath."

Inflation is also an important factor. Young investors can be protected by equities and earnings increases in their portfolios. Older people in or near retirement also can be protected by equities, but their target-date fund should also include treasury inflation protected securities (TIPS).

Every year, the inflation factor should be revisited in a target-date fund and modified if necessary, said Greg Long, executive director at Federal Retirement Thrift Investment Board of Washington.

The end goal needs to be evaluated and that is providing participants with an income stream that will last through their retirement, maintaining their standard of living and leaving a legacy, said Scott Warlow, assistant vice president of asset allocation portfolios at John Hancock of Boston.

John Hancock's lifecycle retirement funds seek to deliver a low probability of negative returns over any rolling 12-month period, Warlow said. Additionally, there is no right level of equities at retirement, but research demonstrates for reasonable withdrawal rates, a balanced portfolio leads to a higher probability of not outliving your wealth than an all-bond or all-stock portfolio, he commented.

However, the industry has to be careful not to market lifecycle funds as an end-all solution for retirement income, panelists noted. These are not guaranteed products, and they should not be positioned as such, said Peter Brady, senior economist at the Investment Company Institute of Washington.

Target-date funds are not mini-defined benefit plans, commented Benjamin Poor, associate director at Cerulli Associates of Boston. Unless a target-date fund has best-of-breed managers, actual defined benefits, an infinite lifespan, use of alternatives and investment consultants, then these funds should not be marketed as mini-defined benefit plans, he said.

For all their growing popularity, target-date funds face critical challenges. As these are relatively new investment solutions-the first target-date fund was introduced in 1993 but they didn't start to flood the market until the past few years-the industry only knows how these investments will perform in a bull market. Should a prolonged bear market occur, "we need to make sure people do not get scared and pull out of the investments" if the returns start going downward, Sturiale said. Individuals need to be educated that these are good vehicles, but they can fall in value, and if they believe they won't, then "we haven't done our job," he added.

Panelists also debated the use of alternative investments in funds, such as real estate investment trusts and exchange-traded-funds. The use of alternative investments in a portfolio needs to be positioned in manner that it does not scare investors and it is not too far out on the risk spectrum, Sturiale said.

"Diversification in a fund needs to be assessed in order to enhance the rate of return and reduce volatility," Clark said. Emerging markets stocks and REITs, for example, can be highly risky. Simply because plan sponsors want alternative investments in a target-date portfolio, using them might not be favorable, Clark said.

The industry is starting to see investors use target-date funds in creative ways, panelists noted. Some risk-adverse investors who are set to retire soon and should be in the 2010 retirement fund are opting for the 2040 fund.

Investors are essentially managing their own risk structure, explained Dirk Laschanzky, a portfolio manager with Principal Global Investors of Des Moines, Iowa.

The creative uses have been interesting, Laschanzky said. People who are set to retire in 2022 are blending 2020 and 2030 funds, he said.

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