From the September 2008 issue of Boomer Market Advisor • Subscribe!

The new (boomer) generation of fund products

Increased longevity and a down market are just a few of the concerns facing boomers in retirement. The mutual fund industry is stepping up with products designed specifically for boomer needs. What's real and what's rank in the latest product offerings?

Before the equity market bubble of the late 1990s burst, with retirement still at least a decade away for most baby boomers, it seemed acceptable for a 50-something who loved the links to buy a mutual fund that invested exclusively in the golf industry.

But amid intensifying concern among boomers and their advisors about stretching retirement dollars over a lifetime, there's little room left in the mutual fund world for whimsy. For the boomer generation and the fund companies that cater to it, pre-2000 playfulness has yielded to post-millennium practicality. Style-above-substance offerings have largely been ousted in favor of products designed to appeal to boomers by emphasizing functionality over a freewheeling, devil-may-care approach.

Sure, there are still special-purpose products aimed at investors with distinctive tastes and an irreverent streak, from vice funds with holdings in the tobacco, alcoholic beverage and gaming industries, to funds that invest exclusively in companies that sponsor NASCAR auto racing events. But when it comes to baby boomers and their mutual funds, frivolity is out, says Jeffrey C. Keil, principal at Keil Fiduciary Strategies, a mutual fund consulting firm in Littleton, Colo.

"The [mutual] fund business went through sort of a gimmick phase in the mid-to-late '90s. But a lot of the less-than-sensible options have since been taken off the table."

Many of the boomer-oriented mutual funds to hit the market recently take direct aim at the pressing principal-protection, income-generation, tax-mitigation and wealth-transfer challenges that generation is confronting. A large number are designed to overcome the decumulation challenge: How, given longevity and inflation risk, to effectively manage retirement drawdowns by positioning and spending assets so they provide a lifetime of retirement income.

From managed-payout funds to lifecycle funds and beyond, the new generation of boomer-oriented products relies more on alternative asset classes, including commodities, currencies, exotic derivatives and the like, Keil says.

"Many of these funds mimic the hedge fund model. The appeal of using alternative investments is that they allegedly will tone down volatility."

By incorporating more alternative investments into their products, fund companies are targeting investors who want a more exotic feel to their funds, explains Loren Fox, senior research analyst at Strategic Insight, a financial research firm in New York City.

"Fund companies are moving toward products that look more like what you find in the institutional money management industry. They are taking strategies and products that appeal to the very wealthy and creating retail versions that appeal to the average investor."

But for today's boomers, says Keil, it's not enough for funds to provide access to alternative investments.

"Boomers have set the bar pretty high. They want it all -- low volatility, income and growth," he says.

"All," according to John Ameriks, who heads Vanguard's investor counseling and research group, also means the ability to preserve liquidity -- particularly in case of unanticipated expenses during retirement.

Fund companies have their work cut out to deliver products that meet those lofty expectations. From niche-type funds to products built for the mainstream, mutual fund experts say several new and emerging fund types are poised to enjoy long shelf lives specifically because they resonate with boomers.

Companies such as Vanguard, Fidelity, ING and John Hancock lately have touted income-generation and managed-payout funds, which are designed to help investors manage the asset decumulation process leading into and during retirement. Some are built to stretch payments over a lifetime; others offer a finite payment period. Most provide a payout in the range of 3 to 5 percent of net asset value annually.

"They're all very new, so none of them have a lot of money in them yet," Fox says. "It's too early to tell, I think, how successful they will be."

Vanguard launched its first three managed payout funds in early May. By mid-June, those funds held some $278 million in assets.

"We think that's a respectable start and on the high side of what we expected," Ameriks says.

The company is positioning the products as an alternative to traditional annuities, without the high fees and penalties for withdrawal of principal. It expects the funds to appeal particularly to people seeking to roll assets out of employer-sponsored retirement plans into a diversified portfolio. Structured as funds of funds, they are designed to function much like an endowment by investing over the long term to build and preserve capital, while generating a targeted, steady monthly payment that can be reset annually. Ameriks says such a structure should appeal to boomers, with whom "there's not a great willingness to aggressively spend their money down. They want to do it prudently."

Vanguard's managed payout funds are commission-free and carry average weighted expense ratios of 0.57 percent to 0.58 percent, with a $25,000 minimum investment. Their holdings include low-cost Vanguard domestic and international stock index funds, bond and REIT index funds, inflation-protected securities and money-market instruments, plus commodity-linked and market-neutral investments. Part of their returns may come in the form of return-of-capital, a tax-deferral strategy that can enhance near-term income.

Managed payout funds are one of many income-oriented funds unveiled by fund companies in recent years. According to Keil, most of them generate income via traditional and more exotic sources, from preferred stocks and dividend-paying equities to call option writing and currency overlay.

Heavily marketed to boomers, lifecycle funds have emerged as a popular solution for investors who prefer a simply packaged, auto-pilot approach to asset decumulation.

"Some are for more conservative investors who are more concerned about preservation of capital than keeping pace with the indices," says Keil. "Others are for people who want to spend every last nickel before they die."

He and Fox see lifecycle funds as a mainstay in the mutual fund mix going forward, chiefly because of their simplicity.

"You park some money in there and forget about it. That appeals to a lot of people."

Investors also like the diversity of lifecycle funds, says Kathleen Beichert, senior vice president of retirement plans at OppenheimerFunds.

"They offer fairly high exposure to traditional equities as well as alternative asset classes," she says. "The traditional notion of retiring used to be to invest in CDs and a Treasury ladder and call it a day. But now people are more comfortable with certain types of alternative investments that serve to decrease volatility."

While lifecycle and managed payout funds represent broad-stroke solutions, fund companies also have been busy developing products that take aim at narrower investor needs. That catch-all category includes so-called 130-30 large-cap stock funds, which invest 30 percent of their holdings in short positions and 130 percent in long positions.

"The idea behind these," explains Fox, "is that fund managers, in researching stocks they think will do well, will also discover stocks they think will do poorly. Instead of avoiding stocks they think will do poorly, they simply short those stocks and buy the ones they think will perform well."

Tax-efficient funds are also carving out a niche in the boomer market, as evidenced by the proliferation of "AMT-free" funds that can relieve certain investors of their alternative minimum tax burden. Funds that offer return-of-capital distributions also are built to minimize taxes and maximize income in the near term. There's also a category of state-specific municipal bond funds that provide investors in individual states with tax-exempt income.

From funds that fill a niche to products designed for the masses, fund companies have their hands full satisfying a boomer generation that demands so much out of its investments.

"In product design, we walk the fine line between providing really targeted products and making products with enough broad appeal to be sustainable. That's not always easy to do."

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