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A Decrepit Decade Just Keeps Getting Worse
By Ron Surz 
October 6, 2008

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How about the old folks?

Recent losses can be especially devastating for those in retirement, who are living off their savings. An investment loss can usually not be made up by going back into the workforce, so the standard of living must adjust instead. Many retirees, as well as those who are saving for retirement, have invested in target date funds. These funds start out aggressively when the target date is distant and then become more conservative as the target date draws near. Those who have reached retirement are in “Current” funds, meaning the target date arrived sometime in the past. These are also sometimes called “retirement income” funds.

The following exhibit shows that investors in target date funds have indeed suffered during the past 9 months, and they’ve suffered much more than our benchmark. Target Date Analytics (TDA), in conjunction with PLANSPONSOR, has created benchmarks for target date funds. Importantly in this environment, the PLANSPONSOR On Target Index for current funds is invested entirely in inflation-sensitive safe vehicles, namely Treasury bills and Treasury Inflation-Protected Securities (TIPS). TDA believes that this is the appropriate allocation for the end of an “accumulation” fund, and that the investor should be making a second decision at retirement about appropriate distribution vehicles, such as annuities. For more information on target date benchmarks, please visit www.TDBench.com.

The exhibit shows the performance of the 3 largest target date families – Vanguard, Fidelity, and T. Rowe Price. These 3 providers currently dominate the target date fund industry, representing about 85% of this $200 Billion market.

Target Date

As you can see, investors in near-term current and 2010 funds have lost 6% and 13% respectively in just the past 9 months, and those in longer-dated funds have lost 20%, underperforming our benchmarks by about 10% across the board. Investors should be disappointed because these funds have failed to protect, especially those in near dated funds. Near dated funds are held mostly by the first Baby Boomers, now in their 60s. Using the 5% rule, a 15% loss robs these folks of 3 years of retirement dignity; it’s a shame that is likely to be felt and paid for by future generations. But the real shame is that these losses should have been avoided. Most of the recent underperformance of these funds, in both absolute terms, and relative to the benchmark, is explained by aggressive equity allocations. The following exhibit contrasts the “glide path” of the typical mutual fund to that of the benchmark. The glide path is the allocation pattern through time, especially the allocation to equities.

Equity Commitment

Detailed analyses of the 3 major fund families, plus another 35 fund families, are available in “Popping the Hood III”, the 3rd installment of an annual comprehensive review of a growing list of target date fund families. This year the cost of the study has been substantially reduced so it is readily affordable by just about any serious target investor who visits www.TDBench.com


These have been trying times, and may be a harbinger of more to come. As long as we’re paying the price, we might as well learn as much as we can from the lessons of these markets.
Here are a few lessons from this decrepit decade that can help us going forward:

  1. Investors are entitled to be concerned about recent capital market behavior. It’s been awful. “Staying the course” just hasn’t cut it, and might not going forward. But there’s a penalty for us all running to the door at the same time. The biggest risk we face is a panic-induced Pogo predicament: “We have met the enemy and they are us.” These are very tough decisions.
  2. Moving to certain styles, sectors or countries may help defend but hedging has worked best. Of course, investors can hedge on their own through the use of derivatives, or moving to cash.
  3. This is a good time to stress test managers for skill. You know that stuff about what the tough do when the going gets tough. But it is absolutely critical that the benchmark is accurate. Some will get fired for the wrong reasons, and then their replacements will get hired for the wrong reasons too. Clients need to know what a “fair” loss should be, given what the manager does. Hint: off-the-shelf indexes only work on index huggers.
  4. Selecting target date funds is currently problematic because this industry as a whole has entered into a performance race, and is exposing investors to too much risk, especially near target date. The timing for these moves to higher risk was bad, but it will be even worse if we don’t learn from this lesson: target date funds should defend better near target date.

If you’re looking for my opinion about the future and practical courses of action, I am as challenged by these markets as the rest of us. Global stock markets plummet when the bailout plan is not approved and when it is approved. Munis yield more than taxables. Gold goes down with everything else. Finance outperforms. TIPS tank. It’s like the god of random punishments is toying with us. There are   opportunities in these dislocations, but they’re not for the squeamish or the amateur.  I do foresee high inflation in the not-too-distant future. We’ve been spending beyond our means for a long time.  Inflation benefits debtors, the biggest of which is the US government, and this debtor has the ability to print money.

APPENDIX: Surz Styles

Style groupings are based on data provided by Compustat. Two security databases are used. The U.S. database covers more than 6000 firms, with total capitalization exceeding $18 trillion. The non-U.S. database coverage exceeds 15,000 firms, 20 countries, and $31 trillion -- substantially broader than EAFE.

To construct style groupings, we first break the Compustat database for the region into size groups based on market capitalization, calculated by multiplying shares outstanding by price per share. There are 3 regions maintained in our system: U.S., Foreign and Global. Beginning with the largest capitalization company, we add companies until 65% of the entire capitalization of the region is covered. This group of stocks is then categorized as "large cap" (capitalization). There are generally about 200 companies in this group for U.S., 800 for Foreign, and 1000 for Global. The second size group represents the next 25% of market capitalization and is called "mid cap". There are generally about 1000 companies in this group for U.S., 2700 for Foreign, and 3500 for Global. Finally, the bottom 10% is called "small cap". There are generally 5000 U.S. securities in this group, 10,000 Foreign, and 15,000 Global.

Then, within each size group, a further breakout is made on the basis of orientation. Value, core, and growth stock groupings within each size category are defined by establishing an aggressiveness measure. Aggressiveness is a proprietary measure that combines dividend yield and price/earnings ratio. The top 40% (by count) of stocks in aggressiveness are designated as "growth," while the bottom 40% are called "value," with the 20% in the middle falling into "core."

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