As the debt-ceiling crisis unnerved markets last summer, target-date funds sank. During the third quarter of 2011, funds with maturity dates of 2016 to 2020 lost 9.6 percent, according to Morningstar. It was an uninspiring showing for the target funds, which are designed to serve as stable choices for 401(k) and other retirement accounts.
But not every fund suffered. For the period, Invesco Balanced-Risk Retirement 2020 (AFTAX) gained 2.3 percent. The Invesco fund stayed afloat by following a careful strategy that involves holding a big fixed-income stake. Other cautious funds that excelled in the downturn include Allianz Global Investors Solutions 2020 (AGNIX), John Hancock2 Retirement Choice at 2020 (JRWOX), and Wells Fargo Advantage Dow Jones Target 2020 (STTRX).
Holding diversified mixes of stocks and bonds, target-date funds seek to offer portfolios for savers who will retire around certain dates, such as 2030 or 2050. As the retirement date approaches, the funds gradually shift to fixed income. While the average fund in the 2020 category keeps half its assets in cash and bonds, the cautious funds have most of their portfolios in fixed income.
The conservative strategies aim to attract plan sponsors that worry about preserving assets in erratic markets. So far the cautious group remains small; most plan sponsors prefer choices with bigger equity allocations. Managers of the cautious funds admit that they may underperform in bull markets. But in recent years, the conservative funds have excelled by avoiding big losses.
Among the least volatile choices is Invesco 2020, which returned 3.5 percent annually during the past five years, ranking as the top performer in its category. To make sure that big stock declines dont swamp the portfolio, the fund puts most of its assets in a risk-parity strategy. The aim is to balance holdings so that each asset class accounts for an equal amount of the risk. In its neutral allocation, the risk-parity strategy has 90 percent of holdings in government bonds, 30 percent in stocks, and 30 percent in commodities. (The numbers add up to more than 100 because the fund uses leverage.)
Worried about the threat of recession in 2011, Invesco raised its bond allocation to 120 percent of assets. The bonds performed quite well when there was a flight to quality, says portfolio manager Mark Ahnrud.
This year the fund lowered the bond allocation to 70 percent. For the year through August 10, the fund returned 7.3 percent, trailing the S&P 500 and most competitors.
John Hancock offers a variety of different target-date strategies, ranging from aggressive to cautious. A more aggressive 2020 fund has 65 percent of assets in equities. The fund will have about 50 percent of assets in equities at the target date. Among the tame options is John Hancock2 Retirement Choice at 2020, which has 60 percent of assets in fixed income. At retirement, the conservative fund will have 92 percent of assets in fixed income. The fund is designed for investors who want a higher degree of certainty of what their balance will be in a few years, says Steve Medina, head of global asset allocation for John Hancock Asset Management.
While some target-date funds have small stakes in inflation-protected securities, Allianz Global Investors Solutions 2020 takes an extreme position, putting 36 percent of assets in the sector. As the target date approaches, the fund increases its inflation holdings. Retirees hold more than 58 percent of assets in inflation securities. If you are going to have a retirement of 20 or 30 years, then you need some kind of protection against inflation, says Allianz portfolio manager Stephen Sexauer.
Sexauer concedes that his cautious funds may not be the best choice for every plan. Recently Allianz made a presentation to a Fortune 50 company that was seeking new 401(k) options. The company which has a strong defined benefit plan passed on the Allianz fund. They said that their employees already have lifetime income, and they wanted to supplement the defined benefit plan with 401(k) assets that are heavily in stocks, says Sexauer.