Target target date risk much earlier, says research firm

The Financial Research Corp. is recommending that target-date funds sharply curtail riskier investments well before they approach maturity — based on the assumption that investors will roll over their assets. “If you're within five years of the target date, we feel that it's prudent to reduce the risk characteristics significantly, with the assumption that retirees will roll over the money to another fund and not have the time horizon to address the risk,” said Larry Petrone, director of research at FRC. On Monday, the firm revealed its first asset allocation recommendation for target-date funds. The recommendation is based on interviews with 12 fund managers holding $300 billion in lifecycle fund assets. Target date or life cycle funds are intended to cut back on riskier investments as a plan participant approaches retirement. But the funds generated considerable controversy following the 2008 market downturn. At the time, investors in some life-cycle funds that were closing in on their target dates discovered that the funds were actually heavily invested in equities. Indeed, some of those funds held 65% of their assets in stocks – and therefore took a shellacking when the market tanked. Funds that are reaching maturity now — including the 2010 funds that were battered in the 2008 decline — are being rolled over, Mr. Petrone added. “While the intent of the asset manager is that you hold the fund for 15 years or more,” he said, “there is a fair amount of rollover activity.” The FRC's research also revealed that the funds themselves aren't aligned with investors' goals. Thus, the participants' behavior doesn't necessarily match with what fund companies expect employees to do. In addition, the FRC suggested that target-date fund providers concentrate on reducing risk as the fund's maturity date nears by controlling price volatility and raising allocation to fixed income investments. The study revealed that many funds have been attempting to address inflation with Treasury inflation-protected securities and commodities exposure via exchange-traded funds or investments in commodity-linked companies. The study also covered the use of annuities in target-date portfolios, a strategy some mutual funds are examining, Mr. Petrone noted. He added that it wouldn't make sense to add a variable annuity when retirees are approaching retirement. Still, the products do provide some market upside potential, as well as the the ability to adjust the pay out.