The Target-Date Industry in 5 Charts
Highlights from Morningstar's 2014 Target-Date Series Research Paper.
Morningstar recently released its 2014 Target-Date Series Research Paper. Here are a few of the findings that may matter the most to target-date fund investors, via some of the paper's most interesting--and sometimes surprising--charts.
1. What a Difference a Year Makes
To the chagrin of some fund companies and the relief of others, target-date series saw their 2008 returns roll off of their five-year performance numbers in 2013. For many series, losing the record connected to that year’s market turmoil resulted in dramatic changes in their relative results.
Exhibit 1 averages the return ranks for each target-date series’ vintage years for the five years as of year-end 2013 and compares them with the five years ended 2012 (which includes 2008 results). On average, series saw more than a 20-point difference in their average ranks. In contrast, the change from 2011 to 2012 produced an average difference of just 10 points.
The Invesco Balanced-Risk Retirement series saw the most dramatic change: For the five years through year-end 2013, funds in the series ranked, on average, in the 85th percentile; it previously averaged in the 13th percentile over the five years through 2012. Invesco has one of the more unusual asset-allocation glide paths in the industry, with a large emphasis on commodities. Its change in standing is an extreme example of how a series that had strong trailing returns in 2012 saw the tide turn in 2013.
More equity-heavy series saw the opposite phenomenon, with the John Hancock Retirement Living series seeing the largest improvement. Its average rank improved from the 62nd percentile in 2012 to the 11th percentile in 2013.
2. Veteran Managers Have Delivered Results
Among target-date series, more-experienced managers have generally delivered better results. That’s reflected in Exhibit 2’s upward-sloping graph: Series that use underlying funds with longer average manager tenures (those at the top of the chart) tend to have better Morningstar Ratings (those to the right). Target-date series managers (the managers who run the target-date funds themselves, as opposed to the underlying funds) with longer tenures are also associated with better series performance, as demonstrated by the graph’s larger circles generally falling to the right side of the exhibit.
That combination has worked especially well for T. Rowe Price Retirement, which enjoys some of the industry’s longest-serving managers and also has an average Morningstar Rating of 4.8 stars. That showing is outpaced only by the TIAA-CREF Lifecycle Index series, which averages 4.9 stars. The managers of TIAA-CREF’s underlying funds average just 5.3 years of tenure, but given the straightforward nature of index investing, longer tenures at the underlying funds arguably hold less sway over series’ results. Instead, those target-date funds have benefited from a glide path that tends to favor equities relative to the competition.
3. Pay Attention to What’s Under the Hood
In addition to asset-allocation decisions, target-date series’ underlying funds and strategies play important roles in target-date funds’ results. Those strategies should be able to stand up to due-diligence scrutiny on their own merits, and the Morningstar Analyst Rating, launched in November 2011, gives one indication of their potential to do so.
For the most part, target-date managers appear to be picking decent--and often strong--candidates that earn Morningstar Analyst Ratings of Gold, Silver, or Bronze. Series generally don’t use underlying funds that have Negative ratings; the Negative-rated AllianceBernstein Retirement Strategy series is somewhat of an exception, though not technically so. Rather than investing in funds, the series invests directly in a pool of securities that is run by the same teams managing funds that are rated by Morningstar. Two of the strategies used by the series are similar to AllianceBernstein International Growth (AWPAX) and AllianceBernstein International Value (ABIAX), which both receive Analyst Ratings of Negative.
Assets in Neutral-rated funds also tend to be in the minority. The Russell LifePoints Target Date and Invesco Balanced-Risk Retirement series are notable exceptions: Of those series’ underlying funds that are rated by Morningstar analysts (rated funds in those series amount to 78% and 67% of assets, respectively), all have Analyst Ratings of Neutral.
For series with at least 50% of assets in underlying funds rated by Morningstar analysts, performance has followed an encouraging pattern: As the upward-sloping line in Exhibit 3 suggests, series with a greater percentage of their assets in Morningstar Medalist funds tend to have stronger overall three-year returns. The relative sizes of the circles show that the highest-ranking series in the group--those from American Funds, T. Rowe Price Retirement, and Vanguard--have also benefited from their heftier equity allocations. However, greater stock weightings haven’t guaranteed success, as Legg Mason’s middling showing and Russell LifePoints’ near-bottom quintile average three-year return ranks demonstrate.
4. Scuffing Some of the Shine From Returns
Morningstar Risk Adjusted Return is a measure that takes into account several factors, including loads, the risk-free rate, and research into investing behavior and utility theory, which show that a given unit of loss tends to produce more "hurt" than the "pleasure" gained from an equivalent unit of gain. It also considers that investors prefer a guaranteed return over an uncertain one. A fund’s MRAR is equal to the guaranteed return that would provide an investor the same level of utility (or "pleasure") as that provided by the fund’s specific pattern of returns, after accounting for sales loads and the risk-free alternatives. Because investors prefer certainty over uncertainty, MRAR is always lower than total return.
The gap between total return and MRAR has varied considerably, depending on the series. Exhibit 4 sorts series by their five-year total returns, from best to worst, and also compares them with their MRAR. The color gradients in all three columns--with green shades being the best, white in the middle, and red shades the worst--give an indication of how the series fare based on the two measures, as well as the difference between the two. The list uses each series’ oldest share class--a common method for screening funds, though it also mixes load and no-load funds in the measurements. For series such as John Hancock Retirement Living and American Funds Target Date Retirement series, those funds’ loads have notably contributed to the difference between total return and risk-adjusted return. For no-load series, the difference between the two figures primarily reflects the psychic discount incurred from the funds’ volatility, particularly on the downside. That discount matters because it helps to determine whether or not an investor is willing to stick with investments through the bad times in order to gain from the good ones.
5. Target-Date Managers Fall Woefully Short on Ownership of Their Funds
Portfolio managers who invest meaningfully in the funds that they manage concretely demonstrate conviction in their strategies. For the most part, target-date series managers come up miserably behind on this measure. Exhibit 5 tallies each series’ highest reported level of manager ownership according to the SEC’s mandated groups.
Hans Erickson of TIAA-CREF counts as the only manager who has more than $1 million--the highest reportable level--invested in a single target-date fund. Almost half of the target-date series in the industry--22 in all--have managers with zero investment in the target-date funds that they manage. The figures are even more disconcerting given that target-date funds are intended to be able to stand as an investor’s entire portfolio.
Some managers--such as T. Rowe Price’s Jerome Clark and the BlackRock LifePath team--say that they have meaningful investments in the non-mutual fund target-date vehicles that they also manage. While that’s more encouraging, it’s not quite equivalent, as they don’t have the same cost experience as mutual fund investors.
In a handful of cases, managers may not meet the highest standard of ownership for the target-date funds that they manage, though they do so within the target-date series’ underlying funds; the team at American Funds fits into this category. And in a few limited cases, the managers may not be able to buy into their funds. This is the case at the Vantagepoint series, which is available only to municipal employees. Those caveats offer some consolation, but the industry as a whole still falls far from ideal.
Note: This version of the article has been changed to clarify total return and MRAR findings.
Janet Yang Rohr, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.