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This Time It's Personal

Because clients will hold target-date funds for decades, it's critical for advisors to judge the people who run the funds.

Laura Pavlenko Lutton, 12/08/2009

Target-date funds are complicated investments, so when choosing one for a client, it's challenge enough to find a fund that contains solid investments, appropriate asset allocation, and a sensible price. But it's important also to train a critical eye on the individuals and organization behind a target-date series. After all, most investors will hold these funds for decades, and over those years, a partnership with a lackluster management team or asset-management firm could compromise a client's nest egg.

Morningstar's Target-Date Series Ratings and Reports, which were introduced in September and are available in Morningstar Office, Direct, and Principia Mutual Funds Advanced, feature two sections of analysis that capture whether the team and firm behind a target-date fund series will be good stewards of capital over the long term. These sections-People and Parent-account for two fifths of the series' overall rating and incorporate qualitative and quantitative analysis. Morningstar's rationale for including these assessments-along with a more-traditional quantitative analysis that considers the target-date series' performance, portfolio, and price-stems from our experience with the Morningstar Stewardship Grades for mutual funds and some revealing data.

(View the related graphic here.)

Putting People into Perspective
Two components make up the target-date family's People rating. Three fourths of the rating is based on Morningstar analysts' assessments of the management team behind the series. The remaining 25% of the People rating is based on management's financial incentives to serve shareholders well.

Morningstar's qualitative analysis of the management team draws on decades of individual fund analysis. Morningstar analysts have been following the funds featured in many of the target-date series for years, regularly interviewing the management teams and determining how well they have executed their investment strategies in a variety of market conditions. That experience puts the analysts in a good position to determine whether those managers tapped for the target-date series are likely to serve sharehold­ers well over the long term.

The management analysis may seem complete­ly qualitative, but it is informed by some quantitative measures. We look at factors such as the fund managers' tenure and retention rates. Funds sponsored by companies that have long tenures and high manager-retention rates are more likely to have the same target-date team in place over the next several years. Meanwhile, firms with relatively low retention rates may suffer future turmoil.

Given the relative youth of target-date funds, there is little value in examining the length of manager tenure overseeing the various target-date series themselves. Evaluating the tenure of the managers of the series' underly­ing funds, however, can be more telling. Another revealing data comparison is the asset-management firm's five-year manager-retention rate. To calculate the manager-reten­tion rate, we look at managers named on the firm's funds at the start of the year. Then, we see what percentage remained at year-end. The five-year manager-retentionrate is the average retention rate over the past five calendar years through Dec. 31, 2008.

Among the fund families offering the largest target-date series, there's quite a range of experience, with the American Funds-which received a top People rating-the clear leader. For American's underlying funds in a target-date series, the average manager tenure on an asset-weighted basis was 23 years. On the flip side, at less than three years, the lowest manager tenure was at DWS. DWS received a bottom People rating. DWS' attempts to improve its fund manage­ment in recent years have led to many departures. It's unclear whether the teams in place now will stay the course or whether turnover will continue.

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