Target-Date and Target-Risk Funds Performing Well

While target-date fund performance was relatively strong for the quarter, many target-date products continue to underperform relative to their Morningstar Moderate Index counterparts, according to research from Ibbotson, part of the Morningstar Investment Management group of Morningstar Inc.

Overall, the funds had a good quarter in terms of performance and experienced healthy cash inflows, Ibbotson researchers say. For the 12-month period ending at the conclusion of this year’s second quarter, the average total return for TDFs fell in the high-teen territory, thanks to strong equity gains in the period.

Still, this is below returns for Morningstar Moderate Index counterparts often looked to as benchmarks for evaluating target-date fund performance. The indexes, besides having the advantage of not incurring active management fees and other expenses, have slightly above-average allocations to emerging markets stocks, which further bolstered returns in the second quarter. So they are imperfect benchmarks for the funds, the researchers admit (see “A New Proposal for Evaluating Target-Date Funds”).

Although there are signs the industry is maturing, flows into target-date funds continued at a healthy clip, Ibbotson says. Total assets in retail target-date funds were over $690 billion at the end of June, representing a 27% increase from a year ago.

Looking to other common benchmarks, the average target-date fund return of 3.8% fell between the returns of the Standard and Poor’s (S&P) 500 and the Barclays U.S. Aggregate Bond indexes for the quarter. As TDFs typically are composed of both equity and fixed-income holdings, it is common to see their performance fall between these indexes, researchers explain.

For the full 12 months ending in June, target-date funds experienced very strong performance, with the average fund ending the period with a 17.0% return. As represented by the S&P 500 Index, U.S. equities posted even stronger returns of 24.6%, while the index’s bond counterpart experienced a muted 4.4% return for the 12-month period.

Ibbotson also published its quarterly evaluation of performance and asset flows for target-risk funds, which pursue a predefined level of portfolio risk instead of basing asset allocations on a predetermined target retirement date. Highlights of the “Q2 2014 Target-Risk Report” from Ibbotson show target-risk funds gained 3.3% on average for the second quarter and 15.1% over the past 12 months.

Target-risk funds saw aggregate flows return to positive territory, Ibbotson says, as $1.8 billion in assets entered the category during the last quarter. As of the end of the second quarter, total assets in target-risk funds were more than $746 billion, a 15% increase from a year ago.

Highlights from the target-date fund analysis are here, while highlights from the target-risk fund analysis are here.