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Are Target-Date Funds Aging Well?

Morningstar's annual study finds strong results alongside leveling growth.

Josh Charlson, 06/27/2013

Target-date series are earning their keep in 401(k) plans. A new Morningstar study out today finds that these retirement investments are getting cheaper, and post-2008 returns have been strong, reflecting broad market trends.

Those trends are consistent with a maturing segment of the fund industry. Target-date series have become fixtures in Americans' defined-contribution plans, with assets crossing the $500 billion mark in 2013's first quarter. The industry's market leaders--Vanguard, Fidelity, and T. Rowe Price--still control about three fourths of the industry's assets, despite impressive growth from some of the industry's smaller players. More new cash poured into passively managed series than actively managed series, reflecting a move in retirement savings toward indexed investments.

As assets have flowed into target-date funds, fees have declined. Target-date series' asset-weighted average expenses clocked in at 0.91% at year-end 2012, down from 0.99% the year prior. Part of that change was likely due to some investors shifting into lower-cost share classes within a given series, as asset-weighted figures give more weight to series' largest share classes. A few other factors have driven the decrease as well. For example, some of the industry's priciest target-date providers, Goldman Sachs and Oppenheimer in particular, shuttered their target-date offerings in 2012.

Rising markets in 2012 and early 2013 helped target-date series turn in strong absolute returns. All but Morningstar's Target Date 2000-2010 category posted double-digit returns for 2012, and all but one peer group--Target Date 2051+--has recouped losses from 2008's market crash. Target-date funds also have reflected healthy gains in the financial markets, especially due to rising equity markets.

A Few Surprises
While many target-date trends are predictable, some of Morningstar's findings were unexpected. For example, some of the industry's debate over how to best manage target-date series' asset allocation may be somewhat overdone. A Morningstar analysis of the average industry glide path shows it should meet the typical retiree's spending needs to age 85, provided the retiree has steadily saved throughout his or her career and sensibly draws on the target-date nest egg. Results begin to notably diverge beyond age 85, however, with glide paths that have less exposure to stocks carrying increased risk that retirees will outlive their savings.

That divergence illustrates the trade-off between market risk (the risk of loss due to the market's price movements) and longevity risk (the possibility of outliving savings) that investors and plan sponsors implicitly face when choosing between different target-date providers. Investors choosing more-conservative target-date strategies may gain peace of mind that their savings balance will fluctuate less on a year-to-year basis than if they were invested in a more-aggressive alternative. In exchange, they give up the potential for higher expected returns that can be as important in the years following retirement as they are in the years before, resulting in an increased risk that they'll outlive their savings.

Ultimately, factors beyond cost and asset allocation may contribute to target-date funds' relative success over the long term. A look at firmwide data for those offering target-date series suggests a tie between better stewardship practices and stronger risk-adjusted performance. Target-date series hailing from firms with longer-tenured managers, higher manager investment in fund shares, lower fees, and better risk-adjusted returns often outperformed, Morningstar found. Those results should reinforce investors' confidence in their long-term commitment to a target-date fund when the provider evinces a history of positive stewardship characteristics.


Josh Charlson is a senior fund analyst with Morningstar.

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