Target-Date Fund First Quarter Winners and Losers

Why didn’t target-date funds beat the S&P 500 or the Morningstar Lifetime Moderate Index for the first-quarter of 2011? Lots in bonds, in the first case. Not as much in diversifiers like commodities, in the second.


Why didn’t target-date funds beat the S&P 500 or the Morningstar Lifetime Moderate Index for first-quarter 2011?

Lots in bonds, in the first case. Not as much in diversifiers like commodities, in the second.

Target-maturity funds’ returns averaged 4 percent for the first quarter, versus 5.9 percent for the S&P 500 Index and 4.6 percent for the Morningstar Lifetime Moderate Index, according to the “Ibbotson Target Maturity Report Q1 2011.” With bonds inching up in the quarter—the BarCap U.S. Aggregate Bond Index rose 0.4 percent—and target-date funds primarily made up of bonds plus equity, “we typically expect returns to fall between the two,” says Jeremy Stempien, a senior consultant at Morningstar’s Ibbotson Associates unit. And the Morningstar Index “is very, very well-diversified, so it uses certain asset classes that helped add returns in the first quarter versus the average target-date fund,” he says, pointing to commodities as an example. Because equities again outperformed fixed income in the quarter, longer-dated funds that usually hold more equity did better than near-dated funds. And target-date funds that had relatively heavy energy weightings in the first quarter saw a significant boost.

Flows into open-end target-maturity funds totaled $16.6 billion in the first quarter, up 7 percent from a year earlier and second only to fourth-quarter 2007 for quarterly results. Stempien points to increasing consumer confidence that led to higher participant contributions in retirement plans, as well as many companies giving their annual 401(k) match in the first quarter, with some of those employers reinstating a match previously suspended due to the economic slump.

Vanguard’s target-date funds had the strongest quarter with 7.2 percent growth, and plan sponsors’ increasing attraction to the use of indexed target-date funds explains part of that. The current scrutiny of 401(k) fees favors indexing. “A provider like Vanguard has lower fees than a lot of its peers, so it tends to attract flows,” Stempien says.

Among other top target-date providers, T. Rowe Price grew at a 5 percent pace during the quarter. And amid what Ibbotson calls “aspiring providers,” JP Morgan and USAA both had positive flows. Morningstar currently ranks three providers in its “Top” rating for target-maturity fund series: American Funds, T. Rowe Price, and Vanguard.

The Ibbotson report mentions that AllianceBernstein “continued its run of outflows as it saw $48 million move out during the quarter.” But that number refers only to its target-date mutual funds and does reflect its overall positive target-date flows, says Thomas Fontaine, global head of AllianceBernstein’s defined contribution business. “The vast majority of our business, which is not counted in the report, is in custom target-date mandates,” he says.

Not surprisingly, given that AllianceBernstein has been moved by Morningstar to its “Bottom” category rating of target-maturity providers (along with Oppenheimer), Fontaine sees problems with how these funds get analyzed. In particular, he says, the tendency to focus on things like three-year trailing performance means that an equity-heavy provider like AllianceBernstein will not look good as long as 2008 remains in the mix.

Fontaine does make a point worth considering for sponsors poring over these sorts of target-date ratings. “It is dangerous for plan fiduciaries if they are guided by these ratings,” he says. “Plan fiduciaries who are tempted to change target-date funds based on these ratings will remove a target-date fund such as ours as a consequence of 2008, then add it back in when it pops back to the top of the ratings—right after it has had a good runup. They will end up selling low and buying high for participants.”