Data & Research January 23, 2012

Target Maturity Funds Bounce Back at End of Year

Target maturity funds experienced a welcome bounce-back during the fourth quarter, according to the Ibbotson Target Maturity Report.
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After an average loss of 11.8% during the third quarter, the fourth quarter saw an average gain of 6.8%. For the full year 2011, the average target maturity fund had a 1.6% loss, driven primarily by the dismal performance of non-U.S. equity markets and commodities, both of which had declines of more than 11%.  

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The fourth-quarter asset class performance saw a sharp reversal of the third quarter’s poor returns in equities and most higher-risk assets. All asset classes posted positive returns over the period, with domestic equities showing the strongest gains. Small-cap equities were the top-performing asset class along with U.S. real estate investment trusts (REITs), all of which rose more than 15%. Large-cap U.S. equities also finished the year strong with double-digit gains. Non-U.S. equities, both developed and emerging, once again struggled on a relative basis, but posted positive returns during the quarter. Diversified commodities (as represented by the DJ UBS Commodity Index) were slightly positive for the quarter.   

Within fixed income, high-yield bonds were the largest beneficiary of the fourth quarter’s “risk-on” environment. Its 6.5% gain was the largest since the third quarter of 2010 and the largest among the fixed income asset classes. Treasury inflation-protected securities (TIPS) returned more than 2% for the fourth quarter in a row and easily beat out U.S. aggregate bonds, short-term bonds, and cash, which posted minimal gains of 1.1% or less.  

For the year, U.S. equity markets were generally flat to negative, with higher risk and non-U.S. asset classes suffering more substantial losses. U.S. large cap stocks managed to post positive returns while small-caps (growth and value) ended the year with losses of 2.9% and 5.5%, respectively. Growth stocks retained their lead over value during this period, although the margin was narrowed after value’s impressive fourth-quarter return. Non-U.S. developed equity fell 11.7%, while commodities were dragged down by emerging market equities, which lost 13.3% and 18.2%, respectively.   

Fixed income gained on the widespread pessimism of investors for equities and other risky assets. U.S. government bonds were particularly strong over the period despite a downgrade of the United States’ credit in the third quarter. This is reflected in the 13.6% return of TIPS and the 7.8% gain in U.S. aggregate bonds. Record-low interest rates kept a lid on the return of short-term bonds, which ended the year up 1.6%.   

 

 

The poor performance of non-U.S. asset classes hurt the performance of target maturity funds with the largest foreign exposures during the past year. Funds with significant allocations to TIPS were some of the better performers, although some of the funds with high TIPS exposure also had high exposure to commodities.  

Target maturity fund flows also recovered after significant declines of 35% and 41% during the second and third quarters. In the fourth quarter, fund inflows increased by 53% to just shy of $10 billion. The Morningstar categories that saw the biggest increase during the quarter were the 2011-2015 and 2016-2020 categories, both with more than 200% flow increases. Fidelity, Vanguard and T. Rowe Price continue to dominate the retail space, accounting for nearly 72% of the total inflows during the quarter.  

Ibbotson tracks 386 unique target maturity funds with at least a one-year track record representing 46 fund families.

 

Data & Research January 23, 2012

Assets in ETF Managed Portfolios Grew 43% in 2011

Total assets in exchange-traded fund (ETF) managed portfolio strategies rose 43% in 2011, according to a report from Morningstar.
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The “ETF Managed Portfolios Landscape Report,” for which Morningstar analysts evaluated the growth, assets, performance, categories and other trends among the ETF managed portfolio strategies included in Morningstar’s database also found:  

  •  The total amount of ETF managed portfolio strategy assets in the U.S. is estimated to be between $40 billion and $100 billion when factoring in discretionary and non-discretionary assets and model portfolios;  
  •  The space is dominated by global strategies (defined as strategies where investors can gain exposure in any global market), which hold more than 72% of all ETF managed portfolio assets);  
  •  The subset of Global All-Asset strategies, which have the ability to invest in multiple asset classes, captured more than half of the asset growth in ETF managed portfolios over the past year; and 
  •  An important factor driving growth is the trend for financial advisers to outsource money management functions to firms specializing in ETF managed portfolio strategies, which allows advisers to focus on managing clients’ overall financial profiles.

In a separate report titled “ETFs Under the Microscope: Tax Efficiency Survey,” Morningstar examined the tax efficiency of ETFs by measuring the frequency of capital gains distributions of ETFs compared with indexed open-end mutual funds over the past five, 10, and 15-year periods. The report found that most ETFs are tax-efficient compared with open-end funds, and the primary driver of ETFs’ tax efficiency is that most ETFs are passively managed index funds.

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ETFs also generate a smaller, but still significant tax savings from their structure—in the event of redemptions, ETFs help minimize taxable capital gains through the ability to exchange securities in-kind.

The report also found that tax efficiency is only one small component of after-tax performance: Expense ratios, tracking error, index methodology, and replication methods may have an effect on returns that exceed any tax benefit. In addition, investor behavior, including managing allocations and minimizing turnover, are more important than the tax structure of an investment vehicle when determining long-term performance.

“We wanted to test the tax efficiency claims that ETF providers have boasted about for years, and it turns out their claims are largely true,” said Paul Justice, Morningstar’s director of ETF research, North America. “However, most passive mutual funds are extremely tax efficient as well, and when all efficiency factors outside of the tax question are put into play, we find that fund structure plays only a small role.”

ETF managed portfolios are investment strategies that typically have more than half of their portfolio assets invested in exchange-traded funds. They are primarily available as separate accounts, and they represent one of the fastest-growing segments of the investment industry.

In September 2011, Morningstar announced plans to research and rank ETF managed portfolios. Morningstar developed a proprietary portfolio attribute classification system based on its analysis of the ETF managed portfolio's investment strategy, as well as a historical review of disclosed holdings.

Morningstar's new system evaluates four main attributes: Universe (which looks at the starting scope of a strategy's investment process on a global basis), Asset Breadth, Portfolio Implementation, and Primary ETF Exposure Type. The information is now available in Morningstar Direct(SM), the company's web-based global investment analysis platform for institutional investors.

Additionally, as a result of the changing distribution dynamics in the industry shown in the report, Morningstar plans to begin systematically collecting assets under advisement (AUA) for separate account strategies in 2012 to better capture assets following a given strategy.

The full "ETF Managed Portfolios Landscape Report" can be found at http://global.morningstar.com/ETFLandscape2012. The full "ETFs Under the Microscope: Tax Efficiency Survey" report can be found at http://global.morningstar.com/ETFTaxEfficiency2012.

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