The market rout >of 2008 was tough on so-called target-date mutual funds. Designed to protect investors by decreasing their exposure to stocks and increasing their bond holdings as people get closer to retirement, the funds performed much worse than expected during the financial crisis.
Many funds have responded by ramping up their holdings of seemingly safe bonds. The problem? Some experts now worry that the bond market is headed for trouble.
The move to safety, in other words, could end up putting investors at more risk. "There's no [inherent] protection in target-date funds," says Robyn Credico, a retirement specialist at consulting group Towers Watson. "It's just an asset allocation."
Fund companies have ratcheted up their fixed-income holdings since the market crash especially in portfolios nearing their investment target year, which is supposed to coincide with holders' anticipated retirement. Of the 45 funds with a target date of 2016 to 2020 tracked by investment-research firm Morningstar Inc., the average has about 32% in bonds and about 58% in stocks up from 25% in bonds and 67% in equities three years ago, according to Morningstar.
Some target-date funds have made much bigger commitments to bonds. Since the end of 2007, for example, MFS Investment Management has increased the bond allocation in its MFS Lifetime 2020 fund from about 25% to more than 40%, according to Morningstar. Similarly, the Columbia Retirement Plus 2020 now has about 26% in bonds, up from 8% three years ago.
MFS says the increase in bonds was dictated by the Lifetime funds' "glidepath," the prescribed asset-allocation trajectory that gets more conservative over time. Anwiti Bahuguna, who manages asset allocation for Columbia Management's target-date funds, says the firm adjusted the 2020 fund after it was acquired last May by Ameriprise Financial Inc. "Improving the downside protection was critical to us," she says.
A host of new funds have debuted in recent years with relatively high bond allocations: The Allianz Global Investors Solutions 2020 Fund, launched at the end of 2008, has about 66% in bonds; the John Hancock JHFunds2 Retirement 2020 Portfolio fund, rolled out in 2010, has 54% in fixed income; and the USAA Target Retirement 2020 fund, introduced in 2008, has 50% in bonds. Allianz didn't respond to calls seeking comment.
Wasif Latif, vice president of equity investments at USAA, says fears of a bond-market collapse are overblown. He expects stocks to become increasingly volatile in the next year.
Steve Medina, who runs the target-date portfolios for the John Hancock family of funds, says a fund's bond exposure matters less than the kinds and quality of bonds it owns. Mr. Medina says he largely is avoiding municipal bonds, which have been choppy of late, and notes that the fixed-income assets in the fund have provided a 12% annual return the past three years.
But for investors looking to retire in the next decade, high bond stakes still could be cause for worry. Many corporate and U.S. government bonds are sitting near record-high prices and inflation and rising interest rates could derail the recent rally, say some advisers and strategists.
"I think we're in a multiyear bear market for bonds," says David Kudla, CEO and chief investment strategist of Mainstay Capital Management, which has more than $1 billion in assets.
Jerome Clark, a manager for T. Rowe Price Group Inc.'s target-date funds, agrees that the bond market could suffer in coming years. The firm, which was widely criticized for heavy stock exposure in its target-date funds in 2008, hasn't changed its allocations: About 27% of its 2020 target-date funds are in bonds.
While retirement experts say target-date funds still provide the best diversification for investors who don't have the knowledge, desire or resources to regularly rebalance their retirement portfolios, some financial advisers are encouraging more independent-minded clients to build their own portfolios.
Jane King, president of Fairfield Financial Advisors in Boston, recently recommended that a 50-year-old client planning to retire in 15 years dump her plan's 2025 target-date fund in favor of individual mutual funds. With or without an adviser, an investor can pick higher-quality funds and a more personalized asset mix than a target-date fund can deliver, she says. For a moderate-risk portfolio, Ms. King recommends a 60% allocation to stock funds like Oakmark Equity and Income and First Eagle Global, and a 40% allocation to conservative funds that include bonds and other assets, like Osterweis Strategic Income and Vanguard Wellesley Income.
At this point, Ms. King says, target-date funds are rarely appropriate. "People think they're safe because they have bonds in them," she says. "I don't think that's safe."
Corrections & Amplifications
A chart accompanying this article on target-date-fund allocations failed to note that the allocations pictured represented 2020 target-date funds.