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Target-Date Results Falling Behind

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The second quarter wasn’t kind to the markets or target-date funds, according to Ibbotson Associates. However, both equity and fixed-income markets had decent 12-month performance results, based on June 30 data, though target-date funds have not kept pace, says the research group, which is part of Morningstar.

“Non-U.S. equity was the biggest drag on target-maturity performance” in the March-to-June period, according to Jeremy Stempien and Cindy Galiano, both directors of investments for the organization and authors of a second-quarter update on target-date funds released in late July.

In the first quarter of 2012, target-date funds had average returns of 9%. But during the second quarter, Ibbotson reports, the average loss for target-maturity funds was 2.8%, nearly identical to the performance of the S&P 500 Index and almost 5 percentage points lower than the Barclays U.S. Aggregate Bond Index. “The poor performance was driven by the dismal performance of non-U.S. equities, which lost almost 7%,” the authors explain.

Plus, the 12-month performance dropped into negative territory, with the average target maturity fund losing 0.5%. Again, this was “driven by the underperformance of non-U.S. equities,” which lost more than 13% over the period. Over the past 12 months, the S&P 500 improved 5.5% and the Barclays U.S. Aggregate Bond Index ticked up 7.5%.

Still, assets kept moving into target-date funds, which benefit from auto-enrollment and auto-escalation features associated with many corporate and other retirement plans. As of June 30, assets in target-maturity funds totaled $431 billion. The “big three,” Fidelity, Vanguard and T. Rowe Price, continue to garner most flows, and captured close to 75% of net flows during the second quarter.

“We typically have observed the average target-maturity performance fall between that of the S&P 500 and the Barclays U.S. Aggregate Bond Index, as the funds are made up of a mix of equities and fixed income,” note Stempien and Galiano. “But over the past quarter and 12-month period, the returns of target-maturity funds have been lower due to non-U.S. equity exposure.”

Asset Classes

Non-U.S. equity markets were the worst-performing equity asset class in Q2, the Ibbotson researchers say. The highly volatile asset class had an 8.8% decline, while developed non-U.S. equity had a 6.9% drop.

Within U.S.-based equity assets, the recent trend of growth outperforming value continued, as did the superiority of large-cap equity over small caps. “Alternatives such as commodities also struggled during the quarter declining 4.6%,” the performance report explains.

“The bright spot was U.S. REITs, which was the sole equity asset class to turn in positive performance. It not only was positive, but had a strong 4.0% return rewarding those target maturity funds that allocated significant assets relative to peers,” the authors share.

Also in the second quarter, all fixed-income asset classes ended the quarter with positive returns. Those with longer duration, such as TIPs and U.S. aggregate bonds, had the best performance vs. U.S. short-term bonds and cash. High-yield bonds, which exhibit a much higher correlation with equities than other fixed-income asset classes, improved 1.8% during the period.

Results for the past 12 months generally reflected the Q2 trends. (See chart).