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Are Some Flexible Funds Proving Academics Wrong?

Tactical target-date funds are outperforming those that don't zig when the market zags.

Janet Yang, CFA, 07/29/2014

Market-timers beware. That's the conclusion of academic studies that suggest it's very difficult for money managers to consistently be correct when it comes to tactical portfolio moves, such as sector or asset-allocation bets on a shorter-term outlook. 

But Morningstar's recently released 2014 Target-Date Research paper has found that target-date retirement fund managers that may tactically deviate from the funds' strategic, long-term asset-allocation paths generally have beaten their peers.

It can be difficult to tell whether a series uses tactical allocation. Often tactical budgets are ill-disclosed in funds' SEC filings and other publicly available materials, so Morningstar only tracks the use of tactical or strategic management for the 22 series under its analysts' coverage. Of that group, nine stick closely to their long-term glide paths, while 13 have varying levels of latitude to opportunistically change their series' shorter-term asset allocations.

Looking at returns through the end of 2013, target-date funds for series that stick to the strategic glide path have an average five-year total return rank in the 54th percentile, while those that use tactical management have a 39th percentile average rank. (On average, the former group beat 54% of its peers, while the latter outpaced 61%).

As a group, tactical series' glide paths also tend to have more equities than those without tactical budgets, which would have provided a tailwind to results during that time. Series that use tactical management average a 63% target equity allocation over 60 years versus strategically managed series' 59% allocation, so the difference is relatively minor. (Sixty years encompasses a 40-year saving-and-working phase from roughly ages 25 to 65 as well as a 20-year retirement from ages 65 to 85.)

The patterns carry through to the target-date series' risk-adjusted results, as measured by their funds' Morningstar Ratings and shown in Exhibit 1. Compared with peers that have similar average equity allocations, series that use tactical management tend to outpace those that do not. (As such, the orange dots tend to fall to the right of the blue dots, even at similar equity-allocation levels.) The typical tactically managed series averages 2.9 stars, while the strategically managed counterpart averages 2.5 stars.

Some of the success has come from series' move to tactically overweight equities. That decision has served the T. Rowe Price Retirement series well, for example, which has had a general tactical overweighting to equities for much of the last decade. That series' suite of target-date funds has an average Morningstar Rating of 4.8 stars. Merely emphasizing equities hasn't necessarily resulted in strong results, though, as the AllianceBernstein series' average Morningstar Rating of 1.4 stars can attest. That series' results have been especially burdened by underperforming underlying strategies, which are represented as pools of individual securities.

Janet Yang is a fund analyst with Morningstar.
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