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Diversification Pays Off for Target-Date Funds

2012 leaders were well-served by global, real estate stakes. 

Josh Charlson, 01/17/2013

It was a very, very good year for target-date funds.

Target-date funds boomed in 2012 on both the growth and performance fronts. In many respects, of course, these investments--key tools in so many investors' 401(k) plans--were just partaking in the general success of the markets. But the funds' highly diversified nature also gave the offerings an additional edge last year, and true disappointments were in a distinct minority.

Healthy Returns Across Categories
Investors in most cases did well in target-date funds in 2012 whether they were just starting out in their working years or getting close to the retirement end line. The target-date categories for investors at least 20 years from retirement (that is, dated 2035 or later) produced average calendar-year returns of 14.7% and higher. That's a solid absolute return by any measure, and within spitting distance of the S&P 500 Index's 16% total return for 2012. The ranges of returns in these long-dated categories were not terribly extreme, either; while the top fund in the 2045 category, JPMorgan SmartRetirement 2045 JSAAX, returned a sparking 18.1%; the bottom performer, Franklin Templeton 2045 FTTAX, still earned a solid absolute return of 10.6%.

Perhaps more surprising are the strong results from shorter-dated funds, intended for investors planning to retire within a few years: The average return of funds in the target date 2011-15 category was 10.7%. Those funds have an average strategic allocation to stocks of 52%, which certainly helped, but the Barclays US Aggregate Bond Index brought in only a 4.2% gain last year. Most target-date managers aren't just sticking to the index, however. Their diversification into areas such as high-yield bonds, Treasury Inflation-Protected Securities, and, in some cases, emerging-markets debt pushed returns ahead. With high-yield bonds last year producing returns on par with those of the stock market, many target-date funds got some extra juice from their fixed-income sleeve.

And although the more aggressive tendencies of some shorter-dated funds produced unexpectedly severe losses in 2008, results since then have worked in favor of investors who were patient. From the pre-crisis peak in 2007 through the end of 2012, all but one of the currently extant 2015 funds have recouped their losses, and most have produced double-digit positive gains.



Top Performers Held More Stocks, More Varied Asset Classes
A deeper look into the leaders and laggards within particular target-date categories reveals the trends that drove relative success in 2012. In the longer-dated categories, the variance in stock allocations is relatively small, so there's not much to be gained by holding more than the average peer in equities. Even so, it's not surprising to find one of the industry's strongest proponents of high equity weightings across the glide path, T. Rowe Price, near the top spot among 2040 and 2045 funds. Among the laggards in the category are those with defensive-oriented strategies, including Invesco, PIMCO, Allianz, and John Hancock's Retirement Choices series. PIMCO RealRetirement, for example, is focused on inflation protection and generation of real income and thus has in its funds for early savers a heavy allocation to commodities--one of the few major asset classes to do poorly last year.

Perhaps the more-defining feature of the leaders from 2012 was their willingness to venture abroad or into asset classes like REITS and to implement tactical overweightings in outperforming areas. The MSCI EAFE, MSCI EME, and REIT indexes topped U.S. stocks in 2012, and most of the top-performing funds in the 2045 category had 30% or more of portfolio assets in foreign stocks. Many of the leaders, including JPMorgan, T. Rowe Price, TIAA-CREF Lifecycle, Putnam, and American Funds Target Date, also employ tactical allocation programs or allow their managers the flexibility to tilt their portfolios opportunistically.

Josh Charlson is a senior fund analyst with Morningstar.
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