The asset allocation funds launched by J&W Seligman & Co. last month look to provide one-stop shopping for people trying to save for retirement. But buyers should beware of the costs associated with these kinds of products.
The three TargetHorizon ETF portfolios are structured as fund-of-funds that invest in exchange-traded funds. Each holds a portion of its portfolio in assets like stocks, and bonds, which are periodically rebalanced, becoming more conservative as a person nears retirement.
The TargETFund Core fund is intended to people who are retired or who expect to retire in a short time. The TargETFund 2015 and TargETFfund 2025 funds are aimed at people who plan to retire, or reach their retirement goals, in those years.
A potential problem with products like these is costs. Funds-of-funds carry expense ratios on top of those of the underlying ETFs, said Rosanne Pane, a mutual fund strategist with Standard & Poor's. Another pitfall, she and financial advisors said, is that commission and transaction costs for ETFs can be expensive.
A fund of ETFs "is a silly marketing gimmick," said Jeff Broadhurst, who heads a financial planning firm in Lansdale, Pa. "Just like fund-of-funds, all you are adding is another layer of costs and complexity," he maintained.
J. Brian Preston, a planner in McDonough, Ga., expressed similar sentiments. "Adding fees takes away many of the advantages of the ETFs," he said.
Seligman, however, believes the new offerings provide a cost-effective asset allocation strategy. Michelle Rappa, senior vice president and director of marketing at Seligman's distribution arm, said that if investors bought individual ETFs they would incur "substantial" transaction costs, unless they made large share purchases. That's because for big purchases, commissions can amount to a small percentage, but for small ones they become much larger.
Srikant Dash, an equity index strategist at Standard & Poor's, thinks the costs of Seligman's new products will be competitive compared to actively managed funds, and will be less expensive than portfolios put together by financial advisors.
The new funds, which offer five share classes, currently have expense ratios ranging from 1.09% to 1.84%, according to their prospectus. These exclude 0.60% in fees or expenses or both that the company has voluntarily agreed to waive until 2008, Seligman said. They also do not include the expenses of the underlying ETFs, which range from 0.09% to 0.75% per year, Seligman said.
The weighted average of the expenses of the underlying ETFs in which the funds currently plan to invest in is 0.26%, the prospectus says. Also, the funds carry maximum sales charges, or front-end loads, of 1% to 5%, depending on the share class.
By comparison, Vanguard Target Retirement 2015 Fund (VTXVX), a mutual fund that is similar to one of the Seligman products, has an expense ratio of 0.22%. Another mutual fund comparable to the Seligman fund, T. Rowe Price Retirement 2015 Fund (TRRGX), had an expense ratio of 0.75% as of last May 31.
Seligman says the advantage of the new funds is that they combine the portfolio diversification and cost advantages of ETFs with so-called target date, or target retirement funds, which are tailored to individual investors' expected retirement dates and are intended as one-size-fits-all retirement portfolios.
ETFs are similar to mutual funds, but they trade throughout the day and can have lower expenses. Unlike mutual fund shareholders, investors in ETFs do not have to pay taxes on capital gains until they sell their holdings.
Target date funds have become popular in recent years. Assets in these funds increased from $25.6 billion in 2003 to $43.8 billion last year, according to Financial Research Corp. These funds held $62.1 billion in assets at the end of last month, FRC said.
The number of these funds offered rose to 86 in 2004 from 61 a year earlier, and another 41 funds were launched or registered to be sold this year, FRC said.
Pane and a number of financial planners said they like target date funds because they make it easier for people to allocate their assets. Preston said the products are "ideal" for individuals who are good at saving, but lack the ability to diversify their portfolios.
However, a disadvantage of these funds is that they fail to take into consideration a person's risk tolerance said Susan Elser, a planner in Indianapolis, In., and Paul Winter, a planner in Holladay, Ut. The funds also don't take into account the date when investors plan to start redeeming shares, Elser said.
Currently, the Seligman funds invest in iShares ETFs from Barclays Global Investors. Seligman plans to offer products incorporating ETFs from other fund companies as well, Rappa said.
Contact Bob Keane with questions or comments at: email@example.com.