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Highlights of Q1 Target-Date Report

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The average return for target-date funds during the first quarter of 2012 was close to 9%, which is about 3.5% below the S&P 500 Index but more than 8.5% better than the BarCap U.S. Aggregate Bond Index, according to a recent report authored by Tom Idzorek, global chief investment officer of Morningstar Investment Management, and Jeremy Stempien, director of investments for Ibbotson Associates.

For the second consecutive quarter, all target-maturity funds with at least a one-year history ended the period with a positive return. Those funds furthest from retirement had the strongest relative performance, as equities significantly outperformed fixed income, the report authors say.

New assets combined with the strong equity performance led to total assets for target-date funds topping $429 billion, an all-time high.

With equities, the momentum from strong performance during the fourth quarter of 2011 carried forward into the first quarter of 2012, with U.S. equities continuing on their roll. The S&P 500 rose 12.6% during the quarter.

Non-U.S. equities also saw improved performance, despite the continued economic turmoil in Europe, according to the Morningstar/Ibbotson research. A lingering low interest rate environment led to a mild performance for fixed income. The combined effect was strong outperformance of target-maturity funds further from retirement, since those funds tend to allocate much higher levels to equity.

 Performance Update

Target-maturity funds enjoyed a nearly 9% return for Q1 thanks to the boost provided by equities. This was the highest return since the third quarter of 2010, when the average target-maturity fund return reached double digits, according to Idzorek and Stempien.

The average target-maturity fund return had a higher return than the average return of the Morningstar Lifetime Moderate Index besting it by 0.3%, which was also the case during the fourth quarter of 2011. Over the past 12 months, though, the index outperformed the average return of target maturity funds by 1.5%.

Fund Family Performance

The performance of nearly 390 target-date funds in about 50 fund families is being tracked by Morningstar and Ibbotson, and recent research found that the overall returns for funds in similar vintages had a very tight range resulting in a clustered set of fund family lines during this period.

Over the 12-month period, there was much less of a pattern among fund-family lines compared to the quarterly graph, and a few families separated themselves from the pack due to their individual-fund strategies.

In Invesco’s Balanced Risk series, for instance, all funds outperformed all other target maturity funds during this period. “This outperformance was driven by Invesco’s use of a risk-parity strategy in the underlying funds, which has led to portfolio exposure in excess of 100% (with leverage) to sovereign bonds, among other factors,” the report concluded.

As was seen during the previous quarter, in the first quarter the best performers were those funds furthest from retirement, with returns exceeding 13%. For the quarter, the index outperformed 59% of target maturity funds across the 13 Morningstar categories, with 41% of funds outperforming the index.

“The categories with the largest percentage of target maturity fund outperformers were those furthest from retirement,” wrote the authors. For example, in the 2055 and 2050 categories, 56% and 60% of the funds outperformed the index, respectively.

For the third time over the past four quarters, funds investing in growth outperformed those investing in value, which rewarded those target maturity funds with a growth tilt during the quarter. After significant underperformance in the previous quarter, non-U.S. developed equity bounced back to end the quarter much more in line with domestic equities, yet still toward the bottom of the group.

“In addition to their diversification benefit,” noted the Morningstar and Ibbotson researchers, “REITs provided a solid boost to return during the quarter as well. Commodities on the other hand provided little in terms of returns with less than a 1% total return during the period.”

 Fund Flows

Target-date funds saw the third-highest quarterly flow since the first target-maturity fund was launched in 1994. “The ‘big 3’ (Fidelity, Vanguard and T. Rowe Price) continued to take in the bulk of these flows with approximately 61% of the nearly $16 billion in flows pouring into their respective fund families,” the report authors say. This is down somewhat from 72% in the previous quarter.

Other firms that experienced positive flows include JP Morgan, TIAA-Cref, and Principal. Some of the seven fund families that had net outflows were funds managed by AllianceBernstein, Russell and Goldman Sachs.

Regarding total net assets, target maturity funds are now at all-time levels with the asset base exceeding $429 billion; this is a 14% increase from the fourth quarter of 2011.

Some players that continue to gain leverage in the industry are West’s Maxim series, Invesco and JP Morgan, which had AUM growth rates of 36%, 30%, and 28%, respectively during the quarter.