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Target Funds Post Strong Q4, Inflows

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Last year ended with a strong quarter as U.S. equity markets recovered from a tough third quarter. This resulted in a volatile, yet flat 12-month performance. As a blend of multiple asset classes, target funds experienced the mixed performance of global markets and ended the year slightly down on average, note experts at Morningstar and Ibbotson Associates in a recent report.

Some 385 target funds from 46 fund families or groups gained 6.8% during the quarter, but they ended the year down an average 1.6 %. In terms of asset flows, quarterly movement bounced back after several consecutive weak quarters of flows, according to Morningstar/Ibbotson. For the quarter, target maturity funds saw more than $9.7 billion of inflows.

Target-fund returns experienced a welcome bounce-back during the fourth quarter, say report authors Tom Idzorek, global chief investment officer, Morningstar Investment Management, and Jeremy Stempien, senior consultant, Ibbotson Associates, noting that they lost an average 11.8% in the third quarter.

“As is typical, the average target maturity fund return is approximately midway between the S&P 500 (11.8%) and the return of the BarCap U.S. Aggregate Bond Index (1.1%),” they explain.

“Somewhat atypically, the average target maturity fund return bested the average return of the Morningstar Lifetime Moderate Index by 0.4%, which is impressive given the consistently strong performance of the index discussed in last quarter’s report,” the authors note.

The Morningstar Lifetime Allocation Index, based on Ibbotson’s Lifetime Asset Allocation methodology, turned in positive returns last quarter (3-9%). For the full year 2011, the best performers were funds closest to retirement, research shows, and there was an extremely wide range of performance (between minus 4.5 and 5.7%). “During the last three years, the overall returns of the indexes have been outstanding with some returns exceeding 14%,” the report explains.

Asset Classes

In the fourth quarter of 2011, many groups were able to reverse the third quarter’s poor returns, including funds in most higher-risk assets, and all asset classes posted positive returns over the period; domestic equities showed the strongest gains.

The top performers were small-cap equities and U.S. REITs, which rose more than 15%. Large-cap U.S. equities also had double-digit gains, while non-U.S. equities struggled on a relative basis but posted positive returns.

Diversified commodities (as represented by the DJ UBS Commodity Index) were slightly positive for the quarter. The S&P GSCI Index, another popular commodity index with a much heavier energy weighting, gained nearly 9%.

“Within fixed income, high-yield bonds were the largest beneficiary of the fourth quarter’s ‘risk-on’ environment,” the report shares. The group’s 6.5% gain was the largest since the third quarter of 2010 and the largest among the fixed-income asset classes reviewed. TIPS returned more than 2% for the fourth quarter in a row, thus easily topping U.S. aggregate bonds, short-term bonds, and cash (which posted gains of 1.1% or less).

Year in Review

Last year was marked by “a string of debt crises, natural disasters and political uncertainties that all led to higher volatility,” note Idzorek and Stempien. Though U.S. equity markets were generally flat to negative, higher risk and non-U.S. asset classes suffered greater losses.

U.S. large-cap stocks posted positive returns, while small-caps (growth and value) ended the year with losses of 2.9% and 5.5%, respectively. Non-U.S. developed equity fell 11.7%, and commodities (minus 13.3%) were dragged down by emerging-market equities, which lost 18.2%.

But fixed income had a different story and gained on the widespread pessimism of investors for equities and other risky assets. Plus, U.S. government bonds performed well despite a downgrade of the United States’ credit in the third quarter. “This is reflected in the 13.6% return of TIPS and the 7.8% gain in U.S. aggregate bonds,” the report states. But low interest rates kept a lid on the return of short-term bonds, which ended the year up 1.6%.

In terms of target funds, those with the largest foreign exposures during the past year were negatively affected. Funds with significant allocations to TIPS, though, were better performers, though some funds with high TIPS exposure also had high exposure to commodities, the Morningstar/Ibbotson experts point out.

Flow Facts

Target maturity fund flows had a major improvement in the last quarter of 2011 after declines of 35% and 41% in the second and third quarters. In the fourth quarter, fund inflows grew 53% to just under $10 billion.

The Morningstar categories with the biggest increase in Q4 were the 2011-2015 and 2016-2020 groups, both with a flow increase of more than 200%. Fidelity, Vanguard and T. Rowe Price accounted for close to 72 of the total inflows in the final three months of 2011. Fidelity bounced back with inflows of nearly $2.2 billion.

PIMCO’s target fund series averaged roughly $7 million in positive flows for the previous four quarters. It then saw its flows jump nearly 20 fold to $134 million during the fourth quarter, according to Morningstar/Ibbotson.

Target funds experienced a 10% decline in total assets from the second to third quarter and then rebounded in the fourth quarter with a 9.5% improvement. According to the recent report, Fidelity, Vanguard and T. Rowe Price are still managing greater than 75% of these assets. PIMCO moved from $87 million at the end of the third quarter to more than $223 million.


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