CHICAGO - Disparities between target and actual asset allocations in some lifecycle funds are so great that conservative funds are more conservative - and aggressive funds more aggressive - than their investment policies state.
That's one of the findings of an analysis of these defined contribution investment vehicles by Ibbotson Associates, Chicago, and disclosed during a presentation at the Profit Sharing/401(k) Council of America conference.
(Lifecycle funds are all-purpose funds that combine investments or funds to satisfy a common goal, such as risk tolerance.)
The disparities are greatest in risk-tolerance funds.
For example, the average target asset allocation for stocks in conservative lifecycle funds ranges between 25%-45%; the actual stock allocation is 10%-44%. This shows that conservative funds are "more conservative" than the funds' investment policy claims, said Mark Riepe, vice president at Ibbotson.
Aggressive lifecycle funds have a targeted equity range of 65%-80%; the actual allocation to stocks is 70%-99% - five to 19 percentage points higher than the target.
For moderate lifecycle funds, the target equity range is 40%-65%, while the actual allocation is 43%-75%.
Similar variations exist between target allocations to bonds and cash in risk tolerance-based lifecycle funds.
Target and actual asset allocations are closer in time-weighted funds.
Funds that classify themselves as short term have a target allocation to stocks of between 15%-40%, the same as the actual allocation. Long-term funds have a target equity range of 55%-90%; the actual allocation is 54%-90%.
According to the Ibbotson analysis of 30 lifecycle products, covering most industry offerings, expenses range from 76 basis points to 375 basis points annually for non-fund-of-fund lifecycle options.
Expenses for fund-of-funds lifecycle products average about 80 basis points, with average wrapper fees for fund-of-funds products adding another 37 basis points.
"The axiom that you get what you pay for is not necessarily true in the money management business .*.*. It pays to shop around," Mr. Riepe said.
"We learned there is tremendous variability across various (lifecycle) products and the target asset allocations, in many cases, don't match up. Products and expenses are all over the map."
Part of the reason for the variation between target and actual asset allocation may be the result of the bull market in stocks. Some managers might boost returns through overexposure to stocks; others could fall behind in rebalancing the funds as the market moves ahead.
"It sounds like they are managing the funds like tactical rather than strategic funds," said Mary Rudie Barneby, president of Delaware Investments & Retirement Services Inc., Philadelphia. Delaware plans to launch a series of lifecycle funds in January.
"Because the market has been so strong, either they are getting 'creative' about their guidelines to take advantage of the strong equity market or are not rebalancing frequently enough," said Ms. Barneby. "These are supposed to be strategic funds but they may be pushing the envelope because of strong market performance."
Joe Masterson, vice president at Diversified Investment Advisors, Purchase, N.Y., said he does not disagree with the Ibbotson findings. He added vendors now are tightening the variation in asset allocation ranges for lifecycle funds.
He said Diversified is "tightening up" its allowable ranges for equity variations from the target to 10% from a 50% variation from the target allocation. Diversified will add two new lifecycle funds to its existing three next year with higher equity exposures "because people want more equities."
Bill Landes, chief investment officer-global asset allocation at Putnam Investments, Boston, said most of the variations in the Ibbotson data may be explained by the allowable variations in lifecycle funds.
He said, for example, Putnam guidelines allow for a 10% variation from the target ranges in equities for its three lifecycle funds. Its conservative fund has a target of 35% equities and allows variations from 24% to 45%.
"We have been toward the upper end of our equity ranges, but we always stay within the target ranges, as specified in the prospectus," said Mr. Landes.
Brian Ternoey, consultant with William M. Mercer Inc., Princeton, N.J., said plan sponsors considering adding lifecycle funds should do thorough due diligence.
"If you are going out to purchase one group (of funds) over another, it can be pretty complex. Lifecycle funds haven't been around that long and it has not been standardized as to what the target allocations are. We also have seen the wide variation in expenses from 30 basis points to over 100 basis points," said Mr. Ternoey.
In addition, he said, it is difficult to establish performance benchmarks for lifecycle funds since "the variation in investments is substantial."
Shlomo Benartzi, a behavioral finance expert and professor at the Anderson School at UCLA, Los Angeles, is a proponent of lifecycle funds. Still, he acknowledged the differences in target and actual asset allocation in these funds is of concern.
But he added: "The way I see these (Ibbotson) numbers is that the actual asset allocation ranges are the correct ones and should be the target ranges. I, as an investor, want a wide range in the targets, and I would feel more comfortable with the actual than the targets."
Yet the "say one thing and do another" approach used by the fund providers is troublesome, Mr. Benartzi said.
"I wouldn't be surprised, though, if many of them went off their original plan due to the market movement, volatility and the strong interest in equities. But it is a concern and raises the issue that really the plan sponsor might consider doing it (setting up its own fund) internally."
Mr. Benartzi also suggested the Labor Department get involved in standardizing the reporting and target asset allocation ranges in lifecycle funds.
