Last month we purchased Fidelity Limited Term Bond (FJRLX) in our model portfolio. Part of our strat...
Two Five-Star Target Funds
08/19/2009 1:00 pm EST
Vaughn Scully of Standard & Poor’s discusses the pluses and minuses of target-date retirement funds, and he names two he says are particularly attractive.
By shifting their asset allocations over time from aggressive, equity-weighted portfolios to a more conservative, fixed-income-oriented posture, target-date funds offer investors a type of “autopilot” on the way to their retirement, eliminating the need to manage the transition themselves.
Target-date funds, sometimes referred to as life-cycle funds, amassed an impressive $176 billion in assets as of April, according to Investment Company Institute data. Fidelity, T. Rowe Price Group (Nasdaq: TROW), and Vanguard are the largest target-fund managers, with about 80% of the market.
About the only thing target-date funds have in common is they assume that contributions will cease once the target date is reached. Most, though not all, are set up as “funds of funds” and invest in both equity and fixed-income instruments. Furthermore, not all funds reach their most conservative allocation in the year they target; some funds don’t reach their most conservative stance for 20 years after the target date, in the belief that investors will need equity-style returns to fund retirement without running out of money.
As successful as these funds have been, a tempest surrounding target-date funds erupted in 2009 in the wake of what Securities and Exchange Commission Chairman Mary Schapiro described as “some troubling investment results” produced by the funds during the market meltdown in 2008. Schapiro said the average fund with a 2010 target date chalked up losses of 25% during the year.
The shock that followed steep losses stems from a generally poor understanding of target-date funds among the investing public: A consumer research study conducted by Envestnet Asset Management and Behavioral Research Associations found that just 6% of respondents could accurately describe how the funds work, and many thought the funds provided a guaranteed return.
[But] these funds do serve a bona fide purpose, especially for investors who are not comfortable managing their portfolio actively. They can help correct flawed investment strategies in which younger people invest too conservatively, and older investors too aggressively.
Just two target-date funds have the highest five-Stars ranking from Standard and Poor’s Mutual Fund Reports: the American Century Target Maturity 2015 fund (BTFTX) and the DWS Target 2014 fund (KRFEX).
The differences between the two are illuminating. The American Century fund (like others in the American Century family) invests primarily in zero-coupon US Treasury and agency debt. Holdings are chosen so that they mature close to the date the fund is targeting.
The DWS fund also invests in zero-coupon bonds, “and the balance of its assets in common stocks.” Its prospectus does not disclose what its initial and final equity allocations are, saying only that the fund readjusts its holdings such that the par value of its zero-coupon bond holdings is equivalent to the original investment in the fund, so investors are protected from losses. According to its disclosure for the period ended June 30, 2009, 87.8% of the fund’s assets were invested in zero-coupon Treasuries, and the rest in common stock.
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