WFC Wells Fargo and Company

By Michael A. Pollock 

Many target-date funds face a challenge in this long bull market for stocks: Their high exposure to equities could result in a sharp drop in their value during a major stock-market pullback.

To damp the possible impact of such a downturn, managers of many of these funds are diversifying into new types of investments -- even as some also boost their stock exposure in hopes of getting better long-term returns and keeping up with competitors.

For example, BlackRock Inc., among the largest providers of target-date funds, with assets of more than $200 billion in them globally, recently recast one of its three fund series with higher equity exposure and investments in smart-beta exchange-traded funds -- index-tracking funds that are designed to both boost returns and lower risk by using factors other than the traditional market capitalization to create their portfolio. John Hancock is diversifying its target-date funds' holdings with a modest allocation to alternatives to stocks and bonds, such as currency derivatives. And investors in TIAA's target-date funds now own a portion of actual buildings -- not just shares in real-estate investment trusts -- such as a 24-story luxury condo structure near New York City's Madison Square Park.

Because some of these strategies are relatively new, it's uncertain how well they will bolster fund performance in another market downdraft, says Jeff Holt, who helps oversee manager research at fund tracker Morningstar. In 2008-09, the most equity-heavy target-date funds shed more than 30% of their value before eventually recovering.

Today, more working people than ever own target-date funds through employer-sponsored 401(k) plans or other tax-deferred accounts. These funds start with very high equity exposure when their investors are presumed to be relatively young and slowly shift toward more-conservative investments as they get closer to retirement -- known as the equity glide path. U.S. target-date assets are approaching $1 trillion.

The need for stock risk

With life expectancies increasing and future returns in many asset areas projected to be lower than they have been in recent years, investors need more equity risk to save enough for retirement, says Fredrik Axsater, a senior executive at Wells Fargo Asset Management. Last year, the firm overhauled its flagship target-date funds, lifting the stock allocation modestly for investors approaching retirement and adding smart-beta ETFs that focus on factors such as valuations, price momentum, volatility and measures of financial health to determine the weightings of their investments.

Because many smart-beta ETFs focus on a relatively narrow slice of the stock market, they can make it easier for managers of target-date funds to tweak strategy in response to shifting market conditions by buying or selling them. And because the ETFs' fees are low, Wells Fargo has been able to trim the expense ratios on its target-date funds to 0.19% of assets annually from a range of 0.30% to 0.37%.

BlackRock made some similar changes. The equity glide path for its LifePath funds, which had started to decline almost immediately from initial stockholdings in the high 90% area, now hovers around 99% for more than the first decade of an investor's participation. That doesn't materially boost risk and significantly improves returns, says Matthew O'Hara, global head of investments for the LifePath funds.

BlackRock also revamped one of its three target-date series to put up to 90% of portfolios into smart-beta ETFs such as iShares Edge MSCI Min Vol EAFE (EFAV) and iShares Edge MSCI Min Vol USA (USMV). That enabled it to lower expense ratios to 0.21% to 0.22%, about half that of its actively managed target-date series.

Northern Trust Asset Management in 2016 lifted the peak equity exposure of its target-date funds by 5 percentage points to 85%. But unlike most peers, its funds start in the low 80% area and don't hit peak stock allocation until a hypothetical investor reaches age 45, about the point when stock exposure starts declining again. That's to trim volatility early on, when people with smaller balances may be more inclined to cash out, says Sabrina Bailey, the firm's global head of retirement solutions. The firm further diversifies by putting some assets into markets that don't closely track stocks, such as commodities and global real estate.

Changes in tools

While it hasn't changed its equity glide path, Principal Financial Group, based in Des Moines, Iowa, recently made portfolio shifts intended to boost returns and damp volatility. Its target-date portfolios, which invest in other individual mutual funds, modestly increased their holdings in non-U.S. stock funds. Some also added a fund that focuses on less volatile, dividend-paying stocks, a move that managers hope will "minimize a little of the downside" during any market corrections, says portfolio manager Randy Welch.

John Hancock's Multimanager Lifetime funds, which also use a fund-of-funds approach, try to steady the ride by shifting to more defensive stocks as the target retirement date grows near. Some of its target-date funds hold as much as a fifth of their portfolios in stock mutual funds that tend to be less volatile than the broad market, in part because they invest in dividend-paying companies with strong financial profiles.

The Multimanager Lifetime funds also have a modest allocation to alternative investments, including funds that wager on gyrations in the global currency market or use various strategies to try to generate gains regardless of how broad asset classes perform. Portfolio manager Nathan Thooft says the allocation to alternatives totals around 4% to 5%.

Real estate for retirement

TIAA has taken an unorthodox step in its Lifecycle target-date offerings: putting some fund money into the ownership of buildings. It began doing that in mid-2016 and eventually expects such holdings to represent about 5% of portfolios.

Although its target-date offerings already had real-estate exposure through holdings of real-estate investment trusts, TIAA tapped into a $100 billion global real-estate fund managed by one of its affiliates to invest directly in properties, says John Cunniff, who oversees two target-date series. "Having a diversifying asset like real estate could be a great benefit during a full market cycle" for stocks, Mr. Cunniff says.

Mr. Pollock is a writer in Ridgewood, N.J. He can be reached at reports@wsj.com.

(END) Dow Jones Newswires

February 04, 2018 22:23 ET (03:23 GMT)

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