Most target-date funds don't deserve the criticism that's been leveled about poor 2008 returns of the 2010 target-date funds, according to a Morningstar Inc. research report.
“Shortcomings with the 2010 funds shouldn't obscure the bigger success story,” according to the report on target-date families — “Target Date Series Research Paper; 2010 Industry Survey” — issued today by the Chicago-based firm.
Morningstar reached its conclusion by looking at target-date fund results in two ways. It compared annualized total returns with annualized asset-weighted returns, which take into account monthly inflows and outflows from the funds.
An asset-weighted return “is a better reflection of an investor's experience than the total return,” Laura Lutton, editorial director for Morningstar's fund research group, said in an interview.
When asset-weighted returns are calculated, “investors are doing OK with target-date funds, and may be better than critics have suggested,” Ms. Lutton said. “If the individual sticks with the funds, they'll do pretty well.”
As an example, the Morningstar report shows the annualized total return of the 2011-2015 target-date category for the three years ended Dec. 31 was -2.32%, while the annualized asset-weighted return for the same period was -0.9%.
(All comparisons in this article reflect three years of returns through Dec. 31, and all results include the impact of fund expenses.)
Morningstar found similar results for each of eight other target-date fund categories: For each category, the asset-weighted results were better.
The one exception during this three-year period was the 2000-2010 target-date group. Morningstar said the annualized total return was -0.97% while the asset-weighted return was -1.23%.
The Morningstar report said the asset-weighted returns for most target-date funds buck “the prevailing trend of the fund industry, where investors tend to pull their money at market lows and chase investments past their peaks.”
The report said investors appear to like the “the set-it and forget-it nature of target-date funds, and as a result they did not panic during the crisis.” Investors' steadiness was aided by target-date funds' prominence in employer-sponsored retirement plans, “where participants contribute on a regular basis and thus have reaped the benefits of dollar-cost averaging,” the report said.
Morningstar also looked at annualized three-year total returns for three types of balanced funds — conservative allocation, moderate allocation and world allocation. In each case, the annualized total return was better than the annualized asset-weighted return, suggesting these investors were making more poorly timed decisions than the holders of most target-date funds.