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 BlackRock Inc, Fidelity Investments and Pacific Investment
Management Co - all firms that have seen returns in their target
date funds lagging competitors - have made adjustments in the past
year so that 401(k) plan participants, particularly those who are
younger to middle age, are more invested in equities. In some cases
employees who are in their 40s now find themselves in funds that are
94 percent allocated into stocks, up more than 10 percentage points.
The changes have prompted concerns from consultants and analysts who
worry that the fund managers are raising the risks too high for
401(k) investors as they seek higher returns, perhaps as a way to
boost their own profiles against rivals.
This anxiety could grow if the recent decline in the U.S. stock
market – the S&P 500 is down 4.5 percent since reaching an all-time
high in mid-September and dropped more than 2 percent on Thursday –
gains momentum. On the other hand, the increased bets on equities
can be seen as a vote of confidence in the bull market, and are also
a reflection of expectations of low returns from bonds in the next
few years if interest rates climb.
"The shared characteristic these funds have is they have not been
doing so well since 2008,” said Janet Yang, a fund analyst at
Morningstar. “The question is if the markets had gone down, would
they have made these changes?"
For their part, executives at these firms say the changes are based
on optimistic long-term forecasts for equities, lowered expectations
for bond market returns and a better understanding of how much
investors, particularly younger ones, rely on these funds as their
primary retirement savings vehicle.
Target date funds contain a mix of assets, such as stocks and bonds
and real estate, and automatically adjust that mix to be less risky
as the target maturity date of the fund approaches. The idea is that
retirement savers can choose a target date fund that lines up with
their own expected retirement year and then not have to worry about
managing their money.
These funds have increasing significance for retirement savers,
because employers can and do automatically invest workers' savings
in target date funds, though the workers can opt out. Some 41
percent of plan participants invest in these funds, up from 20
percent five years ago, according to the SPARK Institute, a
Washington DC-based lobbyist for the retirement plan industry.
Nevertheless, the recent tilt towards heavier equity holdings raises
questions about whether workers are entrusting professional money
managers who might end up buying equities at or near market highs –
the S&P is up 189 percent since March 2009.
"Our concern is that this is happening after a pretty good run in
the equity market," said Lori Lucas, defined contribution practice
leader at Callan Associates, a San Francisco-based consultant to
institutional investors. "If it's a reaction to the fact that some
target date funds haven't been competitive then it is a concern."
A more aggressive approach has worked for some funds in recent
years.
The target date fund families of BlackRock, Fidelity and Pimco have
performed among the bottom half of their peers over the last three
and five year periods, according to Morningstar. Meanwhile, more
aggressive target date fund families, like those managed by The
Vanguard Group, T. Rowe Price and Capital Research & Management,
ranked among the top half of their peers.
As of June 30, BlackRock's three-year return for its 2050 fund was
10.6 percent, according to Morningstar, compared with 10.16 percent
for Fidelity's similar fund and 7.14 percent for Pimco's comparable
fund. Meanwhile Capital Research's 2050 fund returned 13.27 percent
and Vanguard's fund returned 12.26 percent for the same period.
Furthermore, with average expenses of 0.85 percent per year, these
funds charge more than the 0.7 percent in fees levied by the typical
actively managed balanced fund, according to Morningstar. The firms’
pitch is that investors are paying more for peace of mind and a
set-it-and-forget it approach to managing their retirement money.
Workers willing to make their own mix of indexed stock and bond
funds could pay considerably less. The average expense ratio for an
equity index fund is 0.13 percent and 0.12 percent for a bond index
fund.
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"There is some kind of expectation that we are making these changes
because of the equity markets or because of what competitors are
doing and that is incorrect," said Chip Castille, head of
BlackRock's U.S. retirement group.
BlackRock decided to make its changes after a four-year research
project cast new light on how younger workers look at their plans.
Previously, BlackRock's funds were focused on making sure that
investors had enough at retirement. But given that employees' wages
tend to be flat or go up in value slowly, like a bond, BlackRock
wanted to make sure that the target date funds were designed to
provide greater returns during the course of employees' lifetimes,
Castille said.
That, along with the firm's positive 10-year forecast for equities,
resulted in the changes, he said.
With the BlackRock changes, which take effect next month, 401(k)
participants with 25 years left until retirement will see their
equity allocation jump to 94 percent from 78 percent. Investors at
retirement age saw their equities allocation jump to 40 percent from
38 percent.
Executives at the firms note that the increases in equities all fit
within the age appropriate risk for the investors, and that those
investors close to or at retirement are seeing a very small bump in
their equities weightings.
Also they note that they believe the changes will combat risks of
not having enough money at retirement due to inflation and also
address concerns that as people live longer they will need more in
retirement.
Fidelity made its changes in January after it revamped its capital
markets forecasts, which it revisits annually, said Mathew Jensen,
the firm's director of target date strategies.
Specifically, Fidelity has lowered its forecasts for bond returns
from 4 percent a year to 1 to 2 percent, not including inflation.
That along, with internal research that showed that younger workers
were not saving enough, led to the decision.
"None of our work was saying 'hey the equity markets did well, we
should be in equities," Jensen said. "It was about if we have a
dollar today, how do we want to put it to work based on what our
capital markets assumptions are telling us."
Now an investor in Fidelity's 2020 fund has 62 percent invested in
equities, compared with 55 percent previously, while an investor
near or at retirement is 24 percent in equities, up from 20 percent.
Pimco raised the equity allocation in its target date funds late
last year by 5 percentage points for some funds and 7.5 percentage
points for others. The equity allocation for those at retirement is
now 20 percent, up from 15 percent, while those investors planning
to retire in 2050 saw their equity allocation jump to 62.5 percent
up from 55 percent.
"The decision was supported by our view that the global macro
environment had become more stable post the financial crisis," said
John Miller, head of U.S. retirement at Pimco, in an e-mailed
statement.
(Reporting By Jessica Toonkel, additional reporting by Jennifer
Ablan in New York; editing by Linda Stern and Martin Howell)
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