Target date funds faring better in this market meltdown

August 11, 2011

After the 2008 market crash, target date funds came under heavy fire for failing to protect older retirement investors. This time around, TDFs are faring much better – thanks to lessons learned a few years ago.

The basic idea of TDFs — to invest in a mix of assets with the aim of reducing equity exposure as participants approach retirement — is sound, since many investors don’t rebalance or pay attention to reducing risk as retirement approaches.

But many retirement investors don’t really understand how TDFs are allocated between equities and fixed income. Fees can be high, and some critics don’t think TDFs are structured to select the best-in-class funds for all asset groups.

Many TDF investors near retirement age suffered dramatic losses in the 2008 market crash. But an analysis prepared for Reuters Money by Morningstar shows that losses during the recent market meltdown have been far less severe this time for 2010 and 2015 TDF series. Morningstar compared these TDF series against the S&P 500 by measuring from the market’s 2011 peak (April 29th) to the trough (thus far) on Tuesday, August 8.

Morningstar calculated the percentage of the S&P 500 loss sustained by both TDF series, creating a comparative loss ratio that effectively measures how much of the overall market loss was absorbed by the target date funds.

The results point clearly to improvement in managing equity exposure for investors close to retirement:

  • The 2010 fund series had a loss ratio of 43 percent this year, compared with 60 percent in 2008.
  • The 2015 fund series had a loss ratio of 55 percent, compared with 74 percent in 2008.

Josh Charlson, a senior mutual fund analyst at Morningstar and a TDF specialist, cautioned that it’s a bit early to know exactly how TDFs will fare once the dust settles on the current market turmoil. But this preliminary snapshot underscores changes mutual fund companies made to their TDF offerings in the wake of criticisms leveled after the 2008 crash.

“In 2008, many of these funds suffered losses close to what the overall stock market experienced,” he says. “In the last couple years, there’s been movement toward risk control, particularly in shorter-dated funds. A number of the fund series have reduced their equity allocations in shorter dated funds, and there’s also more risk control through hedging strategies.”

The Oppenheimer Transition Fund 2010 (A), for example, was a poster child for bad TDF performance in the 2008 meltdown. The fund lost 41 percent of its value in the calendar year 2008 – worse than the S&P’s 37 percent loss. This year, the Oppenheimer fund is down 9.36 percent from the market’s April peak through Tuesday — significantly less than the 17.32 decline in the S&P 500 for the same period.

Use of TDFs has accelerated sharply in recent years. Vanguard reports that 79 percent of the plans it administers offered TDFs last year, up from 13 percent as recently as 2004. Likewise, 42 percent of Vanguard plan participants used TDFs last year, up from just 2 percent in 2004.

The rising use of auto-enrollment options in workplace plans helps explain the growth of TDFs. Vanguard says 54 percent of participants in plans that offer auto-enrollment used TDFs, compared with 44 percent of participants in plans using voluntary enrollment.

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