M. Patricia Stack

June 2010

It has been a rough couple of years for some target-date funds. Once hailed as easy-does-it, self-contained retirement portfolios for average investors, target-date funds faced widespread criticism during and after the 2008 downturn.

A Senate investigation and two government hearings lastyear questioned whether some of the funds were taking on too much risk and charging excessive fees, and whether they were sufficiently regulated. Industry surveys provoked further worries about companies’ disclosure policies, and how well investors understood the funds.

The issues have taken on particular urgency because targetdate funds are now the centerpiece of many people’s retirement plans. Often named for the year you plan to retire — for example, Fidelity Freedom Fund 2020 — the funds are designed to automatically shift to a more conservative asset mix as your retirement time nears.

Despite the concerns, many industry experts say the funds are a boon to average investors who might otherwise lack even a rudimentary retirement plan. And according to a report released in March by Morningstar, the funds are showing signs of improvement. Over all, target-date funds have recouped most of their losses from the market downturn. And some experts say the criticism may have been beneficial by drawing attention to underlying problems and perhaps inspiring some funds to make changes.

Returns of target-date funds were between 18 and 31 percent for 2009, according to Morningstar’s analysis of the top 20 providers. And despite the complaints, $45 billion in new cash flowed into the funds that year.

In many ways, a shot heard ’round the investment world was the dire performance of some target-date 2010 funds in the downturn of 2008. Many held 50 percent or more of their assets in equities — just two years before investors would have needed the money in retirement, according to a February 2009 report issued by the Senate Special Committee on Aging. At least one 2010 fund lost 40 percent, the committee found, more than the drop in the overall stock market.

Fund companies noted that their equity holdings were stated in prospectuses and said some risk was necessary to keep fund returns steady for retirees — many of whom would hold the fund past the maturity date.

According to Morningstar’s analysis of 2010 funds, equity allocations as of late last year varied from 26 percent to 65 percent. The report noted that while funds with more equity exposure were hit harder in 2008, they also rebounded more vigorously in 2009. A greater problem, some believe, is that fund prospectuses did not set forth their asset allocation strategy in detail, or in a way ordinary investors could understand. Surveys in 2009 by the Employee Benefit Research Institute and Janus also indicated that many people who own target-date funds lack a clear understanding of how they work.

Senator Herb Kohl, Democrat of Wisconsin and chairman of the Senate aging committee, has been a vocal critic of these funds. In two hearings held by his committee last year, he called for lower management fees, clearer disclosure of the funds’ risk management strategy and greater regulation.

Last April, Charles Schwab announced that it would cut the expense ratio of its target-date funds by 12 to 23 basis points, or hundredths of a percentage point, and provide greater exposure to fixed-income assets in earlier years, among other changes. Other target-date fund companies have announced similar changes. In October 2009, Wells Fargo cut its expense ratio for institutional target-date funds by 17 basis points. In the same month, TIAA-CREF and Fidelity each started a new series of target-date funds based wholly on index funds, which are known to have lower fees. In both versions of the funds, Fidelity has added exposure to commodities and Treasury Inflation-Protected Securities, or TIPS, to improve returns and protect against inflation, said Jonathan Shelon, co-portfolio manager of Fidelity’s target-date funds.

M. Patricia Stack

Financial Advisor

Private Client Division

Oppenheimer & Co. Inc.

115 Broadhollow Road Ste 150

Melville, NY 11747

Tel (631) 425-8521