(Chart via Morningstar)
Target date funds performed pretty much in line with expectations amid the coronavirus bear market meltdown in March and they were certainly not immune from extreme selloffs, according to Leo Acheson, director of multi-asset ratings and global manager research at Morningstar.
Outcomes during the Feb. 20-March 20 period, however, varied significantly for near-retirees, highlighting the importance of investors knowing their specific target date fund's risk profile, he pointed out Monday in an article on the firm's website.
While the diversification benefits of TDFs "dissipated, that's not abnormal during extreme sell-offs," he pointed out.
Another key takeaway from his research was that TDFs "held up better during the coronavirus drawdown than they did during the global financial crisis, a sign of industry progress," he said.
TDFs have grown in popularity in 401(k) plans, with assets passing $2 trillion as of Dec. 31, he noted. Their "highly diversified portfolios and systematic reduction in risk as retirement approaches also make them strong options for hands-off investors putting taxable money to work," he pointed out.
However, the "sharp selloff caused by the global coronavirus pandemic served as a good reminder that, despite extreme diversification, not all target date funds are created equal," he said. Therefore, he warned: "Investors should be especially cognizant of their target date fund's risk profile as they approach and enter retirement, when their nest eggs have likely peaked and they begin to rely on those savings to support their lifestyle."
Investors who expected to retire this year and had 2020 TDFs lost more than 17% on average, while those expecting to retire in 40 years (with 2060 TDFs) lost 31%, which was a "minor improvement versus U.S. equities, which fell 33%, and global equities, which declined 32%," he said.
TDFs have "captured more of the equity market's downside than would be anticipated from their strategic equity weighting," he pointed out, explaining:
"While seemingly counterintuitive, that aligns with expectations. During more-modest equity selloffs, bonds typically provide ballast, rising in value as equities fall. But during severe drawdowns, like the ones experienced this year and during the global financial crisis, correlations across asset classes rise, and even investment-grade bonds are susceptible to losses. Indeed, target date fund bond portfolios declined alongside their stock portfolios, exacerbating losses in the recent meltdown."
In comparison, during the global financial crisis, when U.S. equities tumbled 55% cumulatively from their October 2007 peak to their March 2009 bottom, investors planning to retire in 2010 on average lost 67% as much as U.S. stocks, he pointed out. Investors planning to retire in 2020 fared better during the COVID-19 sell-off, capturing on average 55% of the U.S. market's 33% loss, he said.
