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Vanguard's Target-Date Funds Earn Top Marks

Oppenheimer brings up the rear, according to new Morningstar reports.

Laura Pavlenko Lutton, 09/15/2009

Morningstar's fund analysts cover 2,000 mutual funds. Their full analyst reports, including Stewardship Grades, are available in Morningstar Principia Mutual Funds Advanced and Morningstar Advisor Workstation Office Edition.

When Morningstar.com pulled back the curtain on its last week, Vanguard Target Retirement funds were standing in the spotlight, while Oppenheimer got the hook.

A brutal market environment in 2008 dug a wide trench between winners and losers, but target-date funds' performance in last year's market slide is only part of the story here. It's true that the Vanguard funds' losses were relatively slimmer, while Oppenheimer's funds took it on the chin. Oppenheimer Transition 2010 OTTNX, a fund designed for investors retiring next year, lost a whopping 41% in 2008, which was a full 18 percentage points worse than the fund's category mean.

But the Morningstar Target-Date Fund Series Rating and Research Reports consider far more than performance in their evaluations. The methodology also evaluates the people, parent, portfolio, and price behind the funds. Target-date series that earn a Top rating have not only delivered good, risk-adjusted performance for shareholders, but they exhibit other best-practices that should make these funds stand out over the long term.

Management Matters
Morningstar begins its evaluation of a target-date series by examining the fund's management team. Fund series that earn Top ratings for People are run by managers who are experts in their fields. Morningstar looks not just at the named managers on the target-date funds; in cases where the target-date funds are funds of funds, the managers of the underlying funds are considered. In addition, we examine fund managers' pay plans and personal investments to see if they are structured so that each manager's primary incentive is to deliver strong long-term returns to shareholders, an industry best practice in our view.

Vanguard, American Funds, and T. Rowe Price stood out for their superior management teams, with each earning Top ratings for People. All three firms have high five-year manager-retention rates, and their target-date funds feature experienced managers likely to stay for the long term. In addition, the fund firms' pay plans align managers' own financial interests with shareholders'.

At the American Funds, for example, the average tenure for a manager running one of the target-date funds' underlying holdings is more than 23 years, and less than 2% of the firm's fund managers have changed in each of the past five years. Those trends should give target-date investors confidence that there's little flight risk associated with these funds' management talent.

Some series with lackluster ratings for People, including Fidelity Freedom, have managers at their firms that we like, but their funds aren't included in the target-date series. Fidelity likely left out managers like Joel Tillinghast of Fidelity Low-Priced Stock FLPSX and Will Danoff of Fidelity Contrafund FCNTX because their offerings have been closed in recent years and couldn't soak up the assets that have streamed into Fidelity's target-date funds. Even so, investors in this target-date series aren't getting Fidelity's A-team.

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