Set-and-forget leads to superior asset-weighted returns, Morningstar data shows.
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By Morningstar Fund Analysts | 03-16-10 | 06:00 AM | Email Article

Target-date funds have had their share of negative press since 2008's market slide, but a recent study by Morningstar shows most target-date fund investors have stuck with these funds and earned better returns than conventional data would suggest.

Morningstar fund analysts cover more than 1,700 mutual funds and write regular commentary covering fund industry news, fund investing trends, picks, portfolio planning, international investing, and more.

No other fund of any flavor has attracted as much criticism as target-date funds, and no other type of equity mutual fund has sold so well in recent years. In contrast with other funds that contained large amounts of stocks, target-date mutual funds picked up new assets throughout the late 2000s. Morningstar estimates that $146 billion have flowed into target-date mutual funds over the past three calendar years. In each of those years, every single category of target-date funds enjoyed positive inflows, from Retirement Income funds on the short end to Target-Date 2050+ funds on the long end.

The strength of those inflows stems from target-date funds' position as the default investment choice in defined-contribution plans. However, target-date funds aren't growing solely because of captive assets. Redemption rates in target-date funds are below the fund-industry average, despite press coverage that often suggests participants have been deeply unhappy with their returns.

Shareholder Stick-to-Itiveness
Investors' willingness to stick with target-date funds has led to stronger returns with target-date funds than with other mutual funds. Investor returns, which reflect the returns earned by cash flows in and out of funds each month, exceed total returns in all but one target-date category and exceed total returns from other types of mutual funds over the past three years.

For example, the typical fund in the Target-Date 2026-30 category lost 4.46% each year, on average, for the past three years through Dec. 31, 2009. But the asset-weighted investor returns over the same period were better--a loss of 2.71% each year. That's slightly better than an investor fared in the moderate-allocation category over the same year. There the typical investor lost 2.77% per year, even though the funds' total return norm was a 1.97% loss.

Average Returns % by Morningstar Category through Dec. 31, 2009
Category
Annual Return 2009
Annual Return 2008
Total 3-Year Return Annualized
3-Year Investor Return (asset weighted) Annualized
Target Date 2000-2010
22.42
-22.46
-0.97
-1.23
Target Date 2011-2015
23.55
-27.76
-2.32
-0.90
Target Date 2016-2020
24.25
-29.46
-3.09
-2.05
Target Date 2021-2025
28.32
-34.15
-3.88
-1.70
Target Date 2026-2030
28.87
-36.04
-4.46
-2.71
Target Date 2031-2035
30.06
-37.04
-4.68
-1.93
Target Date 2036-2040
30.90
-37.94
-5.07
-2.15
Target Date 2041-2045
30.88
-38.11
-5.12
-0.14
Target Date 2050+
32.20
-38.86
-5.66
-0.02
Conservative Allocation
20.29
-18.91
0.68
-0.64
Moderate Allocation
24.13
-28.01
-1.97
-2.77
World Allocation
24.49
-28.98
-1.21
-2.23

 

Black Eye for Near-Retirees
The category of target-date funds that investors didn't own well was Target Date 2000-10. Those funds, which saw sizable net redemptions in the 2008 market slide, have a three-year annualized loss of 0.97% on average, while a typical investor's loss was greater--1.23% per year. Redemptions in this category peaked in 2008's second half, locking in losses that topped 25% in many cases. Morningstar speculates that many investors sold target-date funds because they didn't understand the risk these funds were assuming and because fund companies' explanations of these offerings are so poor. The biggest challenges facing target-date fund companies are devising ways to effectively communicate their asset-allocation philosophies to investors and properly setting expectations for performance. 

Aside from funds for near-retirees in a market crisis, however, target-date funds' investor returns have bucked a fund-industry trend in which investors tend to pull their money at market lows and chase investments close to their peaks. Why? Certainly, much of it can be attributed to target-date funds' prominence in employer-sponsored retirement plans in which participants contribute on a regular basis and thus have reaped the benefits of dollar-cost averaging. Nevertheless, it seems likely that overall, shareholders like the set-it-and-forget-it nature of target-date fund; and as a result, they did not panic during the 2008 market crisis.

This investor-returns trend also bodes well for target-date funds providing a good investor experience over the long term. Mutual fund assets tend to stick in funds in which shareholders are rewarded with strong risk-adjusted returns, low fees, and good stewardship practices. Those are winning funds for shareholders, as well as for the fund industry.

The following analysts contributed to this article: Josh Charlson, senior fund analyst; David Falkof, fund analyst; Michael Herbst, associate director of fund analysis; Laura Pavlenko Lutton, editorial director; and John Rekenthaler, vice president of research.

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