The MInnesota Investor: Target maturity funds miss bull's-eye

the minnesota investoR

Gene Walden

They were billed as "investing on autopilot"-- so-called ''target maturity'' mutual funds that are designed to change in asset mix and risk level as you get closer to retirement.

But last year, when the stock market took its historic plunge, many 401(k) participants who were on the verge of retirement saw a precipitous drop in their target maturity funds. What's worse, many of those investors had recently been moved into the funds as the 401(k) default option from much more conservative investments.

"In the past, the default option for retirement plan participants had been money market or stable value funds," said Susan Stiles of Edina-based Stiles Financial Services. "But in late 2007 and 2008, as more 401(k) plans started using target maturity funds, they started moving participants from those conservative stable value funds into target maturity funds."

The timing could not have been worse. The stock market had one of its worst years in history, with the Standard & Poor's 500 composite index dropping about 38 percent in 2008. Many target maturity funds fell even further -- including some funds that were targeted for investors who were planning to retire within the next few years.

Targeted maturity funds, which are offered by large mutual fund companies, are typically made up of a variety of funds managed by the same mutual fund company. "It's a great way for those mutual fund companies to keep all of the assets in their own mutual fund family," Stiles said.

Target maturity funds typically carry target dates such as 2010, 2020, 2030 and 2040. Investors are encouraged to invest in the target funds that most closely coincide with their anticipated year of retirement. For instance, if you expect to retire in 2031, you would invest in the 2030 target maturity fund. Under the strategy, younger investors would begin with a fairly aggressive portfolio, and as they grow older and closer to retirement, the asset mix would be adjusted to a more conservative allocation.

But last year, many of the 2010 funds -- which were supposed to be tailored to investors nearing retirement -- suffered substantial losses. Among the 34 funds with target dates of 2010 tracked by Morningstar Inc., the average loss was 24.5 percent.

"We saw a very wide disparity in the 2010 funds," said Josh Charlson, senior analyst with Morningstar. "More than half of the 2010 target maturity funds had losses of at least 25 percent."

The worst was the Oppenheimer Transition 2010 Fund, which was down 41.3 percent, according to Morningstar. The 2010 funds from John Hancock, Principal, Goldman Sachs and Alliance Bernstein were all down more than 29 percent. One of the best was the Wells Fargo Advantage Fund, which was down just 11.2 percent.

"A number of companies had big blow-ups in their core bond funds," Charlson said. The negative effects of the plunging stock market were compounded by the dismal performance in their fixed-income investments, particularly aggressive bond funds and mortgage-backed securities.

'Glide path' confusion

Part of the problem with the 2010 funds was that some fund managers had different objectives than others. Some of the 2010 funds were geared to the investor's retirement date while others were geared to the investor's life expectancy. The ones geared to life expectancy took a much more aggressive approach, since investors could live another 20 to 30 years after retirement.

"Investors need to understand what the "glide path" is for these investments -- whether they are managed with a time frame through age 65 or through life expectancy," Stiles said. "The fund companies did not do a good job of communicating those objectives."

Said Charlson: "The fund companies need to be more transparent in what they're doing, why they're doing it and what asset classes they are investing in. They need to do a better job of communicating their glide-path criteria to investors."

In light of the 2008 debacle -- and the investor complaints and lawsuits that followed -- many fund companies are tweaking their approach to target maturity funds. "Some of the fund families are reviewing everything from top to bottom," he said.

"I think the concept of target maturity funds is good, but the application is flawed and was rolled out too quickly without the proper due diligence," Stiles said.

Investors may also want to take more control of their own retirement assets, choosing the components of their own portfolios rather than relying on prepackaged target maturity funds. "People need to be more careful with their retirement assets," said Stiles. "They need to take control of their own investments."

Gene Walden lives in the Twin Cities and is the author of more than 20 books about business and investing. Send questions to gwalden100@comcast.net.

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