February 9, 2014

Target-Date Funds: Winners & Losers of 2013

Morningstar research points to the types of funds and fund families that beat the pack

Target-date funds had average total returns of 5.4% for the fourth quarter of 2013, according to a recent Ibbotson Associates report.

Those returns fell behind those of the S&P 500 (10.5%), mainly due to target-date funds’ holdings in non-U.S. equities, bonds and real-return asset classes, like real estate investment trusts and commodities.

For the 2013 calendar year, the average total return for target-date funds was a respectable 16.3%. This performance (again) was roughly half the S&P’s jump of 32.4% and behind the results of foreign developed-market stocks, which gained 23.3%.

But target-date funds topped returns of many other investment categories for the year, including high-yield bonds (7.4%) and REITs (3%). Categories with losses last year included commodities (-9.5%), Treasury inflation-protected securities (-8.61%), and bonds as measured by the Barclays U.S. Aggregate Bond Index (-2%).

Morningstar (MSTAR) analyst Josh Charlson points to the Vantagepoint Milestone 2045 (VQRJX) as the top performer in the 2141-2045 group, with ’13 returns that nearly reached 28%. Other fund families with strong results in 2013 include American Funds, T. Rowe Price and TIAA-CREF.

“Although that [28%] gain does not match the 32% leap of the S&P 500 Index in 2013, the numbers are impressive nevertheless, especially considering that the typical 2045 fund held at least 10% of assets in bonds and devoted a significant portion to non-U.S. stock markets, which did not keep up with U.S. equities,” explained Charlson in an online report.

During Q4, flows into target-date fund had a sizeable rebound, nearing $13 billion compared with $2.3 billion in the earlier period.

Target-Date Issues

At the end of 2013, one-third of retail investors' target-date fund assets were in passively managed target-date funds, up from 24% five years ago.

Total assets held by investors in target-date funds were nearly $621 billion, a 28% jump from the end of 2012, thanks to both bullish equity markets and continued positive flows. Fidelity, Vanguard, and T. Rowe Price hold more than 73% of the retail market, but this share continues to decline.

Still, Vanguard’s index-based target-date series, for instance, took in more than $18 billion in new assets last year — more than double the new assets of any other target-date fund series.

While retirement plan sponsors infrequently switch from one target-date series to another, leading target-date providers are seeing changes in their asset levels, according to Jeremy Stempien and Cindy Galiano, both directors of investments for Ibbotson, which is a unit of Morningstar.

“Whereas five years ago Fidelity’s target-date series held 39% of the industry’s assets, it now holds just under 30%,” they noted. “Meanwhile, Vanguard’s market share has increased to 27% at the end of 2013 compared to 22% at the end of 2009.

“In addition, JPMorgan’s series has attracted significant assets in recent years and now holds a 3% market share, up from less than 1% five years ago. T. Rowe Price’s market share has stayed relatively constant at 17%,” Stempien and Galiano explained.

Some of fastest-growing series in Q4 included those managed by Allianz (35% growth to $163 million), JP Morgan (25% growth to nearly $19 billion) and American Century (15% growth to more than $10 billion).

Of the 42 fund families with target-date mutual funds, only nine experienced outflows in their open-fund assets in 2013, such as ING ($329 million), AllianceBernstein ($261 million) and Russell ($194 million).

Portfolio strategies that allocated limited amounts of their portfolios to commodities, emerging markets, real estate and TIPS, such as the Nationwide Destination products, helped them outperform their peers, the analysts say. They also note that the “above-average equity weights in the American Funds’ glide path also assisted the series in averaging a top-three percentile category rank in 2013.”

In addition, Fidelity (among others) moved to increase the equity exposures of its Freedom target-date funds, “resulting in a glide path that more closely resembles its competitors,” according to Morningstar’s latest target-date report. Also last year, American Century rebranded its series as “One Choice” (abandoning “Livestrong”).

Target-Risk Returns

Funds with a select risk profile (conservative, moderate and aggressive) gained 5.0% on average in the fourth quarter and nearly 15% in 2013. Plus, these funds experienced healthy flows of $2 billion, says Ibbotson, with growth-oriented funds gathering the majority of the flows.

As of the end of Q4, total assets in target-risk funds approached $713 billion, an 18% increase from a year ago. The research group says it is “surprised to find that few target-risk funds are actively lowering interest rate risk ahead of expected tapering of the Federal Reserve’s bond purchase programs.”

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