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Outsourcing Asset Allocation

Thanks largely to advisors, dynamic funds of funds are taking their turn in the spotlight.

Laura Pavlenko Lutton, 12/03/2012

This article originally appeared in the December/January 2013 issue of MorningstarAdvisor magazine.  To subscribe, please call 1-800-384-4000. 

T. Rowe Price Balanced RPBAX has the trappings of a vintage moderate-allocation offering. It’s a straightforward asset-allocation fund with a fairly static 60%/40% stock/bond mix. After growing quickly through the mid-1990s and then surging again in the early 2000s, its asset growth has stalled. In fact, the fund has lost about 10% of its assets to outflows since 2008, and Morningstar’s analysts stopped following the fund in 2011.

Interest has shifted elsewhere not because this fund is a dud. It sports a 4-star Morningstar rating, and its 10-year record is in the peer group’s top quintile. Even so, it looks a little pedestrian relative to more dynamic offerings that have been on the rise, like target-date funds with their 40-year glide paths and super-slick ETF managed portfolios. In an era when many financial advisors are outsourcing their investment selection, it appears that fancy funds of funds are sparkling.

Seeing the Roots
The concept of a fund of funds isn’t a new one. It’s been employed at T. Rowe Price Balanced and other asset-allocation funds for decades. But the idea of more-dramatically altering a fund’s asset allocation over time went mainstream in 2007 when the U.S. Department of Labor qualified target-date retirement funds as default investments in defined-contribution plans.

Since then, when employees enroll in a 401(k) plan and don’t select specific investments for their retirement savings, they most often end up in the target-date retirement fund whose target year falls closest to their 65th birthday. In the years leading up to that date, the fund’s asset allocation shifts, so it owns less equity and more fixed-income and cash investments. No need for the 401(k) participant—or an advisor— to rebalance the assets along the way. Instead, that task is delegated to the professional fund manager.

The concept of outsourcing one’s asset allocation is being popularized elsewhere, especially in 529 college savings plans. Since 529 plans began to blossom in the early 2000s, most have enhanced their age-based options. These investments are structured like a target-date retirement fund: College savers choose the 529 plan’s age-based option that corresponds with the child’s current age or their high-school graduation year. As the child nears the college enrollment year, 529’s age-based tracks typically move quickly into cash and bonds, to preserve the higher-ed nest egg.

Age-based tracks are understandably popular in 529 plans that are sold directly to college savers, who want to choose a “set it and forget it” investment. But as Kailin Liu points out in “Age-Based Options Take Over 529 Industry”, age-based tracks have been just as popular in 529 plans sold through advisors.

Amping Up the Complexity
As funds of funds with shifting asset alloca- tions have become more common, their insides are increasingly less so. The target-date retirement funds have been using their series as laboratories for new ideas in asset allocation, especially after the funds posted steep losses in 2008’s market slide. On average, target-date funds lost one fourth of their value that year, leading to broad criticism from regulators, elected officials, and retirement-plan participants alike.

Laura Pavlenko Lutton is an editorial director in Morningstar's fund research group. She would love to hear from you, but she can't give portfolio advice.

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