Wednesday, June 6, 2012

Target Date 2015 Funds: Off Target With Risk & Reward


While doing my research for May’s Allocation For Life newsletter, which addressed the topic of “Risk vs. Reward”, I came across some very disturbing data pertaining to target date mutual funds.  The specific target date funds that disturbed me were the 2015 strategies.  The generally accepted definition of a target date 2015 fund is that it is designed for investors who are looking to retire between the years 2013 and 2017.  The front end of that range is just six months away, yet I found that the majority of target date 2015 funds are trading at equal to or greater than risk to the market.

I rely on the statistical measure referred to as “beta” to tell me how correlated a particular mutual fund or portfolio as a whole is to the overall market.  Understanding beta is quite simple.  If a particular investment has a beta equal to 1, then that investment is trading at the exact same volatility as the S&P 500.  In other words, that particular investment is highly correlated to the market.  A beta greater than 1 means that investment or portfolio is trading with a higher level of volatility, some say risk, than the market.  For example, if an investment or portfolio has a beta of 1.20, then that is telling me that the investment trades with 20% more volatility than the S&P 500. If the beta is less than 1, for example a beta of .80, then I know that investment is 20% less volatile than the market.

Now let’s examine the current beta for many of the target date 2015 strategies available and sold to individual investors:

Fund
Symbol
1 Yr. Beta
AllianceBernstein 2015
LTEAX
1.11
Columbia Retirement Plus 2015
CLRAX
0.95
Franklin Templeton 2015
FTRAX
0.92
Goldman Sachs Retirement 2015
GRDAX
1.15
Oppenheimer Transition 2015
OTFAX
1.07
JHancock2 Retirement 2015
JLBAX
1.1
MassMutual RetireSMART 2015
MMJAX
1.15
Principal LifeTime 2015 R1
LTSGX
1.08
TIAA-CREF Lifecycle 2015
TCLIX
1.02
Vanguard Target Retirement 2015
VTXVX
0.91



After reviewing this data it left me asking two questions.  The first question I had was, “Why are these funds assuming nearly equal to or greater than risk to the market with shareholders on the verge of retirement?”  There are some very dark clouds on the horizon and the current level of risk and volatility these funds are exposing shareholders to could derail shareholders retirement plans.  It’s another classic example of individual investors being set up to be stuck behind the eight ball again.  I have no problem with the concept of assuming risk, but that risk should come with some type of reward.  Sure the sun may shine and the clouds may not produce a storm, but you are still left with funds that have not been able to provide much return for the risk being assumed.

This led me to my second question which was, “Ok, you have assumed the risk, but where is the reward?”  I have shown you that these funds are currently assuming volatility right in line with the market (some are assuming less and some are assuming up to 15% more), now let’s examine the trailing five year returns for those funds listed above that have been around that long.  The returns are as follows and as of the close on 6-5-12:

Trailing Returns as of 6-5-12
LTEAX
OTFAX
JLBAX
YTD
-0.52%
1.01%
2.41%
1yr.
-6.12%
-4.64%
-1.95%
3yr. Average Annual
9.16%
8.52%
10.58%
5yr. Average Annual
-2.06%
-4.65%
0.06%
TCLIX
VTXVX
S&P 500
YTD
2.36%
1.87%
3.17%
1yr.
-0.50%
0.38%
2.16%
3yr. Average Annual
9.78%
10.22%
13.30%
5yr. Average Annual
1.03%
1.72%
-1.13%



The risk that has been assumed for shareholders of these mutual funds that are about to enter retirement has not been worth it.  So why assume the risk?  For comparison purposes, I have two models (one of which was outlined in my book) that are available to members of Allocation For Life to own directly at Folio Investing.  They are the AFL 50/50 Defensive Growth Models and are available in mutual fund and etf form.  Both of these models over the last five years have traded with a beta in the range of .44 to .50.  These models are assuming 50% or more less volatility than these target date 2015 funds, and would be my choice for investors on the verge of retiring or in retirement.  Let’s compare these models returns to the above target date returns.  The returns are as follows:

Trailing Returns as of 6-5-12
AFL Defensive Growth MF
AFL Defensive Growth ETF
YTD
2.22%
3.84%
1yr.
0.25%
2.97%
3yr. Average Annual
11.08%
11.47%
5yr. Average Annual
5.90%
4.35%
10yr. Average Annual
8.34%
NA
Return Since Inception 1-1-2000
8.97%
NA



Are these returns better across the board than the returns of the target date 2015 funds I shared with you?  Yes, and this would make me very angry if I were a shareholder of these funds.  Sadly most investors do not realize what they own and many of these funds are tucked away in 401k’s as a responsible option for participants.  The target date funds I shared with you simply have not provided enough reward for the risk they have assumed.  Based on the trailing returns there is no reason to believe that they ever will.  Investors cannot begin to understand how they are going to get where they want to go until they begin the process of understanding risk vs. reward.  In this case, I believe many shareholders assume they are taking on less risk than the market, but that simply isn’t the case.

Thank you and good luck everyone!

Jon R. Orcutt, founder of Allocation For Life, is an asset allocation strategist and author of “Master the Markets with Mutual Funds: A Common Sense Guide To Investing Success”