Allocations to fixed income provided little safe harbor for investors in near-dated target date funds, as bonds' poor performance in the second quarter clobbered the most conservative offerings.
Worries over the Federal Reserve ending its bond purchases threw the bond market into a tizzy during the second quarter of the year, resulting in a massive sell-off during May and June. The Barclays U.S. Aggregate Bond Index declined 2.3% during that period.
Sure enough, the performance slump also took a bite out of target-date fund performance, namely those whose investors are very close to retirement and who are thus heavily invested in bonds. Morningstar Inc.'s Lifetime Allocation Indexes — a benchmark for target-date funds — revealed that the second quarter was particularly tough for funds with maturity dates of 2015 and earlier.
Morningstar's Conservative 2015 index — a balance of 30% stocks, 49% bonds and 13% Treasury inflation-protected securities — experienced a slump of 2.2% for the three-month period ended June 30. In comparison, its aggressive counterpart — with 63% of its allocation toward stocks, 24% toward bonds and 11% in TIPS — had only a 0.6% loss.
Among fixed-income investments, TIPS fared the worst during the second quarter, posting a 7.1% decline in performance, according to Morningstar. High-yield bonds took a 1.4% dive. Meanwhile, U.S. aggregate bonds and U.S. short term bonds experienced declines of 2.3% and 0.1%, respectively.
At the same time, U.S. stocks were among the stronger performers. Domestic large-cap value and small-cap growth led the way with gains of 3.2% and 3.7%, respectively, during the second quarter, according to Morningstar.
For near-dated target dates, it paid off — at least in the second quarter — to invest a little more aggressively in stocks.
Though most 2015 target-date vintages took their beatings in the second quarter, a handful performed better than the others. American Funds' 2015 target date fund had a gain of 0.45%, according to data from Morningstar. Great-West SecureFoundation 2015 took a small loss of 0.18%, while ICMA Retirement Corp.'s Vantagepoint Milestone 2015 logged a loss of 0.35%.
There is a combination of factors at work here, noted Josh Charlson, a senior mutual fund analyst at Morningstar. Funds overweight in stocks had sufficient performance from equities to overcome the losses they may have experienced in bonds, he said.
Other funds may have softened the blow from the slump in bonds by leaning more toward shorter-duration bonds, Mr. Charlson added. Shorter-duration bonds aren't paying much on yields, but as interest rates rise in the future, they may pay a higher nominal rate.
Going forward, we may see more diversification in bond exposure, now that fund managers have had a taste of what rising interest rates can do to their fixed-income investments.
“I think you'll see more fund companies trying to diversify bond exposure by holding more in multisector-bond funds, bank loans and other, more credit-sensitive vehicles that have shorter durations and can provide some higher yields,” Mr. Charlson said. “You're going to have the risk of going down the credit ladder if you do that.”