With all the bashing of target-date funds over the last couple of years, Morningstar has come out with its annual survey regarding the funds. After reading stories in the media, including “Target-date bashing unjustified, Morningstar says: 2010 series performance not indicative of overall funds' return” Pensions & Investments online March 15, we are surprised by the misleading takeaways that Morningstar seems to promote to the media and public, which is unfortunate for the millions of unsuspecting, herded (i.e., defaulted) 401(k) participants out there. The comments out of Morningstar are cheerleading and really ought to be seen for what they are: support for an industry that failed at a primary objective of prudent investment management — managing risk.
Asset-weighted returns should have been better than annualized returns over the three years ended 2009 because of the consistent payroll contributions (dollar-cost averaging) by 401(k) investors into extremely volatile markets. Because target-date funds are dominated by 401(k) investors, it seems logical that they would have had better asset-weighted returns than annualized returns. No news there. Furthermore, it just so happens that many of the 401(k) investors were defaulted, suggesting that the contributions were not a proactive decision. The fact that other fund categories' asset-weighted returns didn't do as well might be attributable to the lack of 401(k) investors in those fund categories (lack of payroll contributions).
Morningstar says in its report on its target-date fund survey that the “unprecedented criticism ... has not deterred millions of investors from making these funds the centerpiece of their retirement savings.” No surprise, many were defaulted by their plan sponsors. And why did plan sponsors default these participants? Because the DOL said these fund options were appropriate.
Another conclusion Morningstar drew from its study was that all proprietary funds outperformed open-architecture funds. A lot of smoke here. Their universe of “open-architecture” funds is dominated by second-tier insurance-company-based funds with weighty expenses wrapping outside funds.
The mutual fund industry blew the asset allocation decision (a most important decision) on the shorter dated target-date funds causing them to underperform the more aggressive target-date funds. Morningstar seems to downplay the issue of this poor performance. It shouldn't be the exception; it should be the focus of the debate — most of the money (larger account balances) is in the near retirees' accounts.
Unfortunately, most of these funds performed just like what we thought. The markets gave us one of those rare glimpses when everything went down together (highly correlated). Interestingly, the fund companies modified a few things and came out with more gimmicks, such as absolute-return and market-timing strategies.
Correcting the flaws in the target-date funds requires one thing — fiduciary responsibility. The lack of fiduciary responsibility is corrected by getting the Department of Labor to see that giving mutual funds a free pass with QDIA, or qualified default investment alternatives, regulations was a mistake that had great consequence.
Axia Advisory Corp.