Monday, January 12, 2009

Target Funds Not Hitting the Target

Keeping up with the "nowhere to hide in this market theme", lets take a look at target date funds. These are funds that adjust their weightings into various asset classes based on the your retirement date. For example, someone not retiring for 30 years would have a higher percentage of stocks vs bonds, and so on. To me, they are gaining in popularity due to a couple of main reasons:
  • The baby boom generation is approaching retirement, thus more people than ever getting serious about IRA's and other retirement accounts
  • People don't want to do their homework on how to invest retirement money
  • More people have become disillusioned with investment managers, and want to do their own investing without doing much research
With 2008 wrapped up, we can see how all of these investments have done. And as it turns out, many of these funds were hit pretty hard, which is expected in a tough year. But the "conservative" funds, or those of people retiring in the next few years were hit pretty hard as well, and that is eye opening.

Among funds targeting retirement in 2010, a few posted declines of 10% or less, but many inflicted losses far exceeding 20%, according to data from investment researcher Morningstar. For investors on the verge of retiring, big losses can have an even bigger impact on how long their money will last.

While one year is a short time frame for measuring funds that may be held for decades, there's a clear lesson: Even for an investment sold as a no-brainer, it's crucial to look under the hood.

A case in point is the OppenheimerFunds target-date funds, where the LifeCycle Transition 2010 Fund lost 41.3% in 2008.

Oppenheimer's offerings use the firm's Core Bond fund as the primary bond holding. That fund lost about 35% last year, thanks to aggressive bets on credit derivatives that backfired. "We're very disappointed," says Oppenheimer's Keith Tucker.

This is surprising. Why is a 2010 retirement fund making agressive bets on credit derivatives? These fund managers are obviously performance chasing in funds that should be worried about preserving capital with some small, steady income.

I did some research of my own into the T Rowe Price funds. I do think they are one of the best fund managers out there, and they are doing pretty well with target funds too. But their 2010 fund lost 26.71% in 2008, which is still quite a bit for a conservative fund. Looking at the fund composition, they are sitting in 45% Domestic Stocks, 37% Domestic Bonds, 11% Foreign Stocks, and roughly each 2.5% in Cash and Foreign Bonds. Doesn't 56% stocks seem a little high for someone entering retirement? Its not outrageous, but a little aggressive, especially in this market. I could be overlooking some re-balancing in these funds though. I don't have their historical compositions, and they could be putting some more money to work in stocks due to cheaper stocks. But I'm still a little concerned about it. Here's the info on their 2010 fund.

The bottom line here is you still have to know what you're buying. There will always be fads in the investment world as long as people are willing to buy what they're selling. I do think these funds make sense, but if they aren't living up to their purpose, what's the use? Index funds are cheaper. I've always been a fan of low cost index funds as your core holdings, especially if you don't want to spend much time with your investments. After that, I like to own a couple of stocks or funds with smaller stakes, and take advantage of time and compound interest.

Here's the WSJ article about this.

Bear Mauls 'Safe' Target Funds, Too

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