Data & Research May 5, 2009

Workers Might Have Wrong Idea about Target-Date Funds

A recent study found that workers have misconceptions about target-date funds.
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It is no secret that target-date funds were created for those that didn’t want to understand investing. However, a recent study by Envestnet suggests that workers might have large misunderstandings about target-date funds—such as that target-date funds are guaranteed.

Only 16% of participants surveyed by Envestnet said they had heard of target-date funds prior to reading the description, and 63% of that group incorrectly described them, according to the study. A couple of definitions included: “funds that will be made available for release for use on a specified date;” and “a [financial] instrument which is due for maturity at a set date in the future, by which date the amounts invested in the instrument are planned to have accumulated a certain amount gain.’

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About half of the respondents said they are neither likely nor unlikely to invest in target-date fund, and 21% said they are likely to.

Target-Date Promises

About 40% of respondents somewhat or strongly agree that investing in target-date funds means that they will earn a guaranteed return. Furthermore, 23% of respondents agree somewhat or strongly that there is little or no chance of losing money before the target-date. About the same number feel the same about losing money after the target-date.

Almost half agreed that investing in a target-date fund means they “can stop worrying about investment and savings decisions and leave everything up to an investment professional.” And almost 30% agree target-date funds mean they can save less money and still meet their retirement goals.

When it comes to the risk of investing in target-date funds, respondents tended not to see a huge difference among fund companies. Respondents said the risk levels of funds with the same target date are slightly similar (46%) or very similar (38%). When compared to investing in stock mutual funds, more than half (52%) of respondents said they are equally likely to lose money in target-date funds in a one-year period; 28% feel they are less likely.

When asked what task is most important when investing in target-date funds, about 28% say it is “picking the right retirement date.” The second largest percentage chose asset allocation as a priority (26.7%); followed by choosing funds with the best historical returns (22.3%); and picking the fund with the lowest expenses (15.1%). The last on the list—cited by only 8% of people as a first priority—was “selecting a savings rate.”

Envestnet surveyed 251 individuals aged 25 to 70 and employed now or in the past year.

The Markets May 5, 2009

Most Asset Classes Negative for Separate Account/Collective Trusts

While the first quarter of 2009 saw an equity market rally, most asset classes had negative returns during the period, according to the latest data from Morningstar’s Separate Account/Collective Trust (CIT) database.
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A Morningstar news release said the median domestic equity strategy in the database lost 9.5% for the first quarter—a substantial improvement over fourth quarter 2008’s dramatic 20.3% loss. Even though equity market givebacks were reduced, there were still losses, resulting in an average one-year decline of 37.1%, and a 10-year return of only 2.2%.

Alternative categories that use various short-selling techniques focused on the domestic equity markets, such as Long-Short, Leveraged Net Long, and Market Neutral, performed somewhat better, losing 3% for first quarter and 9.8% for the year, but posting a 10-year annualized return of 5.1%, Morningstar said.

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International stocks landed in between domestic equity and alternative strategies, with 10-year average returns of 3.9% but three-month and one-year declines of 10% and 45%, respectively.

Fixed-income strategies fared better than equity strategies. The median domestic, taxable bond strategy—the only asset class with a positive three-month return—returned 0.8% in first quarter 2009, lost 1.4% for the year, and had a 10-year annualized return of 5.2%. International bonds declined 1.3% for first quarter 2009 and 9.2% for the year, but their 10-year return of 7.8% was the highest of all asset classes evaluated.

Better Long-Term but Worse Short-Term Returns

Meanwhile, according to the data, separate accounts and collective trusts had significantly better long-term returns but significantly worse short-term returns. Of the 44 categories that overlap between both investment universes and include at least 20 products each, mutual funds outperformed separate accounts and CITs in 68% of categories in March and 59% of categories during the quarter, with average outperformance of 0.77% and 1.09%, respectively.

However, Morningstar said this trend reversed when evaluating the vehicles over longer time periods; separate accounts and CITs outperformed mutual funds in 70%, 73%, and 68% of categories for the one-, three-, and five-year periods, respectively, with average outperformance of 2.52%, 1.12%, and 0.78%.

One possible explanation is that separate account and CIT managers have more flexibility than mutual fund managers because of their lack of registration with the SEC. Their mandates tend to allow for more manager discretion. For example, many domestic equity separate account and CIT managers may be allowed to use derivatives or short a significant percentage of their portfolios, whereas mutual funds often have stricter provisions in prospectuses, Morningstar said.

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