January 5, 2009
Make lemonade when the market gives you lemons: Winning the Losers Game
This is one of those unfortunate times when consultants and investment managers will try to console their clients by explaining how their pain is less, hopefully, than most others. This will be awkward and delicate, and is likely to bring forth the difficult questions about bailing or doubling down. As for good relative performance, we’ll need to look back more than 10 years to find a timeframe where positive returns are winners, because the 10-year annualized S&P500 return for the period ending 12/31/08 is -1.4%. As the following exhibit shows, a 33% loss will win the annual performance race for those who are benchmarked against the S&P500, because a -33% return ranks in the top quartile for the year ending 12/31/08. “Congratulations Mrs. Client your manager performed very well, losing “only” a third of your account in 2008.” Talk about pain management.
The universes in this exhibit are created using an unbiased scientific approach called Portfolio Opportunity Distributions (PODs). They represent all of the possible portfolios that managers could have held when selecting stocks from the S&P500. Traditional peer groups are very poor barometers of success or failure because of their myriad biases. Everyone knows that it’s easy to find a peer group provider that makes you look good, but for some reason the industry tolerates, even condones, this deceptive practice. PODs are bias free and are therefore a much more reliable performance evaluation backdrop, plus they’re available now, many weeks before the “real” biased peer groups. As John Stossel says on ABC TV News:”Give me a break.” You can use the chart below to get an early and accurate ranking of your own portfolio -- just plot your dot.
How about the old folks?
Recent losses can be especially devastating for those in retirement and 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 in 2008, and they’ve suffered much more than our Target Date Analytics (TDA) benchmark. 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 three largest target date families – Vanguard, Fidelity, and T. Rowe Price. These three providers currently dominate the target date fund industry, representing about 85% of this $200 Billion market.
As you can see, investors in near-term current and 2010 funds have lost 12% and 25% respectively in just the past year, and those in longer-dated funds have lost more than 35%, underperforming our benchmarks significantly. Investors – especially those in near-dated funs - should be disappointed because these funds failed to protect. Near-dated funds are held mostly by the first Baby Boomers, now in their 60s. Using the rule of spending only 5% of savings each year, a 25% loss robs these folks of 5 years of retirement dignity since its 5 years of spending at the previous asset level. This is 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 exhibit above 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.
Detailed analyses of the three major fund families, plus another 35 fund families, are available in “Popping the Hood III”, the third 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 and it is readily affordable through www.TDBench.com.Display article as PDF for printing.
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