Target-Date Funds Shrink in Number, but Popularity Is Growing

As investors' memories of the damage wreaked by the 2008 crash fade, asset managers have more tactical strategies when deciding a target date fund's composition—two factors that have contributed to TDFs' renewed popularity, Herman said.

 "The asset managers are giving themselves more wiggle room in the language they use in their prospectus," he said. "They can move around their glidepath, as published in the prospectus, to leave bonds, for example, and invest in something else."

However, that "something else," such as alternative investments, created problems in 2012 for Putnam Investments, which saw a drop in its rating to a 3 (or C) in 2012 from a 1 (or A) in 2011. The downgrade came after Putnam posted a poor performance due to underlying investments in absolute return vehicles, which have not realized the returns that their peers have seen in equities over the past three years, according to Herman.

Putnam officials responded with a comment stating that the firm is focused on consistent, long-term performance, especially during periods of volatility.

"We believe it is critical to look at the performance of a target date series over a full market cycle — including bull and bear markets — and not just take a narrow snapshot of time for an investment vehicle designed for much longer horizons," Putnam officials said. "In these portfolios, Putnam's Absolute Return strategies have performed as intended, serving as a volatility dampener, meant to help generate a smoother sequence of returns over the long haul. Also, it is worth noting that Putnam has intentionally structured its target date glide path to be more conservative than most, with lower equity allocations, to further protect investors from the effects of market fluctuation as they approach their retirement date."

In June 2011, Putnam executives at a retirement panel warned that many target-date funds were too aggressive in their exposure to stocks, putting investors at risk for market downturns after retirement.

At the event, Putnam announced the launch of a retirement investment think tank, Putnam Institute, whose initial study showed that equity allocations in target-date funds since the 2008 financial crisis typically ranged from 35% to 65%. However, the institute's research director, W. Van Harlow, said the percentage of stocks in a post-retirement portfolio should more appropriately range between 5% and 25%.

"Many target date funds are well above that into retirement," said Van Harlow. "The government is becoming concerned about this issue. Plan sponsors don't know what's going on in these target date retirement funds."

Other Popping the Hood VI Findings

• American Century ranked with a top grade again; American Century One Choice Portfolios have received a top grade in every report since "Popping the Hood II"
• JPMorgan SmartRetirement and MFS were also top performers, receiving an overall 5 for the third straight year
• In 2012, 34 out of 48 (71%) fund series had an overlay fee in 2012. Similarly, 34 out of 50 (68%) fund series had an overlay fee in 2011.
• In 2012, 28 out of 48 (58%) fund series had a closed architecture in 2012, while 34 out of 50 (68%) had a closed architecture in 2011.
• Some fees have dropped since the last study: DWS reduced fees from an average of 0.98% to 0.86%. Franklin Templeton reduced fees from an average of 0.97% to 0.88%. MassMutual reduced fees from an average of 0.95% to 0.83%.
• Some fund families increased their average fees from Hood V: BlackRock LifePath Active (formerly BlackRock Lifecycle Prepared) increased fees from an average of 0.72% to 0.82%. Invesco increased fees from an average of 0.74% to 0.81%.
• "The standard to be a truly low-cost, index TDF fund series," says the report, "is now under 20 basis points thanks to Vanguard (0.18%), TIAA-CREF Lifecycle Index (0.18%) and Fidelity Freedom Index (0.19%). BlackRock LifePath Index (0.27%) and iShares (0.31%) are close behind."
• "Fees as a whole are still high," according to the report, which notes that 70 basis points is the average institutional TDF fund, although that has dropped 2 bp since last year.

 Read about BrightScope's Top 25 401(k)s for NYC-Based Companies at AdvisorOne.