The Markets January 28, 2007

Study Finds Lifecycle Funds Doing Well for Investors

A recent study by the Turnstone Advisory Group LLC in Marina del Rey, California has found that lifecycle funds are doing a good job for their investors but areas for improvement include pricing and asset allocation.
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The study, “Popping the Hood: An Analysis of Major Life Cycle Fund Families,” ranks six families of target-maturity funds using both quantitative and qualitative comparative analysis. The study was undertaken because, using fund analysis tools, Joe Nagengast, founder of Turnstone, realized that he could see how one 2020 fund stacked up against another, but there was no good way to compare family to family.

The fund families analyzed in the report are (in ranked order): Principal Investors LifeTime Funds, Vanguard Target Retirement Funds, Fidelity Freedom Funds, T. Rowe Price Retirement Funds, Barclays Global Investors LifePath Funds, and Wells Fargo Outlook Funds.

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When he set out to do the study, Nagengast, said he had three criteria for inclusion: the fund family needed to have three years of performance history as of June 30, 2005; it needed to have substantial assets under management; and it needed to have a mutual fund structure. These three criteria left him with only four fund families; T. Rowe Price and Vanguard were left out because they did not meet the tenure requirement. However, Nagengast and his co-authors decided that it was “silly to complete the study without them,’ so they included those two fund families along with the other four, and just made a note in the research.

After completing his analysis, Nagengast said he found that the funds “seem to be doing a good job so far, but we have some concerns.’ Namely, he said, his concerns centered around fees and asset allocation. The six fund families in the study averaged all-in fees of 71 basis points, a number Nagengast says was significantly lowered by Vanguard’s very inexpensive fees without which, the average expense ratio would have been 79 basis points. In doing the study, Nagengast said he was concerned about fees because he and his co-authors think the funds should be looking to see how marketable and competitive they can be on an expense basis.

Nagengast also has concerns about the allocation of these funds, saying that the differences between the major allocation strategies of each fund are minor and the driving factor of the funds is a large stake in large-cap domestic equity.

In evaluating the fund familes, Turnstone factored six elements into its ratings:

  • performance (30% of the overall score)
  • allocation (20%)
  • expenses (15%)
  • modern portfolio theory (MPT) risk analysis (15%)
  • up/down-market-capture analysis (15%)
  • the funds’ structure (5%)

According to the report, all six fund families rated equally in the structure category, receiving four out of five possible points. That category included numerous elements such as fund inception, assets under management, and proprietary versus open architecture. In evaluating performance, Turnstone looked at both standard MPT analysis like standard deviation and the Sharpe Ratio, and analysis of up/downmarket performance.

Last week, Nagengast took part in a PLANSPONSOR Web cast (which can be accessed here) and said that he is already working on the second edition of the study. The first version evaluated funds based on data through June 30, 2005, and he thinks the second edition, which will hopefully be released near the end of the first quarter of 2007, will use data through year-end 2006.

This second edition should be different, as some funds have made significant changes since the first version of “Popping the Hood’ was released. For example, Wells Fargo has relaunched (and renamed) its funds as the Wells Fargo Advantage Dow Jones Target Date Funds, which it calls the first registered target-date mutual funds that track the performance of the global series of the Dow Jones Target Date Indexes. The funds also have a new subadvisor and the company also shifted the emphasis from active to passive management and altered the glide path used to determine at what pace a target-date fund will lessen its equity allocation.

A copy of the full report can be obtained at http://www.turnstoneag.com/Research.aspx.
IMHO January 27, 2007

IMHO: “Over″ Blown?

Looks like the pension crisis is finally over.
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Well, the funding part of the crisis, anyway. No fewer than three separate studies were published this past week* that essentially said that the pension plans of larger employers are either fully or nearly fully funded again.
For several years now, we’ve been struggling with the impact of the so-called “perfect storm’ on pension plans. The catchy nomenclature was borrowed from the 2000 film by the same name (which, in turn, was pulled from the 1997 book on which it was based)—a reference to the 1991 Halloween Nor’easter that resulted from the unusual combination of several forces of nature to create an exceptionally powerful storm across a very large area. A storm—nearly a hurricane—that caught many off-guard.
The so-called perfect storm for pension plans also resulted from an unusual confluence of factors—a slumping investment market, the “vacation’ from funding that many plans took during a period when soaring investment returns made such actions unnecessary, and, significantly, an unprecedented decline in the interest rate of the 30-year Treasury bond after the Clinton Administration decided to quit issuing new ones.
Back in the Black
In the intervening years, plan sponsors have benefited from investment returns that exceeded projections—as they frequently do over the long term. Also adding to the value of the assets in these programs, plan sponsors have returned to the process of making regular—and in some cases, extraordinary—contributions to the programs. Finally—and this has had a significant impact on the calculation of the liabilities owed by these plans—the return to something like a “normal’ interest rate environment coupled with the use of a blended rate, rather than an artificially distorted 30-year Treasury. It hasn’t been easy, it hasn’t been painless, and it surely hasn’t been “perfect’—but many, perhaps most, large pension plans seem to be back in the “black.’
Not that the funding shortfalls for most were ever as bad as they were portrayed. While there were clearly some villains—and some unsustainable promises dumped on the Pension Benefit Guaranty Corporation—being 85% funded on a pension obligation isn’t all that different from having 85% of your mortgage paid off with 20 years to go (it’s actually better than that).
You’d never have gotten a sense of that from the headlines, or the angst of the legislators. It may be worth remembering that the last time these funds were flush with cash (we’re a long way from that), pensioners were up in arms that the pension surplus should be given to them in the form of higher benefits, analysts were critical of the “gloss’ that pension returns lent to financial reporting, and, frankly, plan sponsors were disinclined to make regular contributions in excess of the required amounts.
It’s worth noting that since this last storm “broke,’ many plan sponsors have chosen to freeze or terminate their traditional pension plans. The reasons are varied, of course. The confluence of factors cited above may have made the program untenable financially; workplace demographics may have cried out for a different retirement plan design; or they may simply have looked ahead to the future and made a different choice.
Still, it’s hard not to wonder how many were set on that path for no reason more substantive than the relentless pillorying of the funding “crisis’ in the media. It was certainly more than a tempest in a teapot—but IMHO, the concerns expressed were always overblown.
*Editor’s note: the studies include reports from Towers Perrin (see DB Funding Landscape Starts to Shine in 2006), UBS (see UBS New Tracker Finds 2006 Pension Improvement), and Watson Wyatt (see A Return to Better Funding for Pensions in 2006)

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