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”
