After an average loss of 11.8% during the third quarter, the fourth quarter saw an average gain of 6.8%. For the full year 2011, the average target maturity fund had a 1.6% loss, driven primarily by the dismal performance of non-U.S. equity markets and commodities, both of which had declines of more than 11%.
The fourth-quarter asset class performance saw a sharp reversal of the third quarter’s poor returns in equities and most higher-risk assets. All asset classes posted positive returns over the period, with domestic equities showing the strongest gains. Small-cap equities were the top-performing asset class along with U.S. real estate investment trusts (REITs), all of which rose more than 15%. Large-cap U.S. equities also finished the year strong with double-digit gains. Non-U.S. equities, both developed and emerging, once again struggled on a relative basis, but posted positive returns during the quarter. Diversified commodities (as represented by the DJ UBS Commodity Index) were slightly positive for the quarter.
Within fixed income, high-yield bonds were the largest beneficiary of the fourth quarter’s “risk-on” environment. Its 6.5% gain was the largest since the third quarter of 2010 and the largest among the fixed income asset classes. Treasury inflation-protected securities (TIPS) returned more than 2% for the fourth quarter in a row and easily beat out U.S. aggregate bonds, short-term bonds, and cash, which posted minimal gains of 1.1% or less.
For the year, U.S. equity markets were generally flat to negative, with higher risk and non-U.S. asset classes suffering more substantial losses. U.S. large cap stocks managed to post positive returns while small-caps (growth and value) ended the year with losses of 2.9% and 5.5%, respectively. Growth stocks retained their lead over value during this period, although the margin was narrowed after value’s impressive fourth-quarter return. Non-U.S. developed equity fell 11.7%, while commodities were dragged down by emerging market equities, which lost 13.3% and 18.2%, respectively.
Fixed income gained on the widespread pessimism of investors for equities and other risky assets. U.S. government bonds were particularly strong over the period despite a downgrade of the United States’ credit in the third quarter. This is reflected in the 13.6% return of TIPS and the 7.8% gain in U.S. aggregate bonds. Record-low interest rates kept a lid on the return of short-term bonds, which ended the year up 1.6%.
The poor performance of non-U.S. asset classes hurt the performance of target maturity funds with the largest foreign exposures during the past year. Funds with significant allocations to TIPS were some of the better performers, although some of the funds with high TIPS exposure also had high exposure to commodities.
Target maturity fund flows also recovered after significant declines of 35% and 41% during the second and third quarters. In the fourth quarter, fund inflows increased by 53% to just shy of $10 billion. The Morningstar categories that saw the biggest increase during the quarter were the 2011-2015 and 2016-2020 categories, both with more than 200% flow increases. Fidelity, Vanguard and T. Rowe Price continue to dominate the retail space, accounting for nearly 72% of the total inflows during the quarter.Ibbotson tracks 386 unique target maturity funds with at least a one-year track record representing 46 fund families.