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The Markets December 16, 2009
Some Target-Dates Visit the ‘Junk’ Shop
A Bloomberg news report said six of the nine largest U.S. target-date fund providers by assets have junk bonds in their 2010 portfolios.
Reported by Fred Schneyer
The Bloomberg story said that while John Hancock’s Lifecycle
2010 mutual fund is marketed as an investment that “becomes more conservative”
for people approaching retirement age, 35% of the fund’s debt holdings in
September were high-yield corporate bonds, according to Morningstar Inc.
For example, according to Bloomberg, the Hancock fund’s
holdings include bonds that financed construction of a New Mexico casino hotel,
Inn of the Mountain Gods, which was in default as of December 15. The U.S.
default rate on high-risk, high-yield bonds was 11.28% in November, according
to Standard & Poor’s.
A single bond in default is “not going to make or break the
fund” because it’s a very small portion of the thousands of bonds in the fund,
Bob Boyda, senior vice president in the investment management services division
of John Hancock told Bloomberg. “Even if a bond is in default it may have
tremendous value.”
The problem, according to Laura Pavlenko Lutton, editorial
director in Morningstar’s mutual-fund research group: Target-date funds may
present greater risks than consumers have been aware, Bloomberg reported. The
target-date funds blossomed into a $311-billion business by 2008, a year after
the U.S. Department of Labor said employers may use them as an automatic enrollment
investment option for 401(k) plans.
Junk Bond Amounts
Other 2010 retirement funds with bonds rated below
investment grade include: Principal Funds LifeTime 2010 Fund, at 21% of its
total debt holdings; the Fidelity Freedom 2010 at 17.1%; T Rowe Price’s
Retirement 2010 Fund at 13.1%; American Funds’ American 2010 Target Date
Retirement Fund at 11.4 %; and TIAA-CREF’s Lifecycle 2010 Fund at 6.6%, as of
the latest portfolio disclosure, according to Morningstar.
Jonathan Shelon, manager of Fidelity Investments’ Freedom
Funds, told Bloomberg that risk is only one of the concerns that someone who’s
about to retire needs to consider. They also need to generate enough income to
last during their retirement years, he said.
Meanwhile, Principal Financial Group and TIAA-CREF said
their allocation in high-yield bonds also offers diversification, according to
spokeswomen for the companies.
Bloomberg said three of the nine largest target-date fund
companies don’t have any junk bonds in their 2010 or 2015 target-date funds:
Vanguard Group, Wells Fargo & Co., and ING Groep NV. Their overall bond
holdings range from 35% in ING’s fund to 65% in Wells Fargo’s fund.
Vanguard Group’s avoidance of high-yield bonds is “very
conscious,” said John Ameriks, head of the company’s investment counseling and
research group. Junk bonds wouldn’t add “significant diversification,” and
would raise expenses, he said.
Junk Bond Objections
“I am extremely disturbed by the amount of junk bonds found
in many 2010 target-date funds,” said Senator Herb Kohl, a Wisconsin Democrat
and committee chairman. “Stronger regulation is needed to ensure that
participants on the brink of retirement are not exposed to such excessive
risk.”
Kohl said in a statement he will introduce legislation to require target-date fund managers to act as fiduciaries if their plans are offered as automatic enrollment options in 401(k) plans (see “Senator Says Target-Date Legislation Coming“).