Target Date Funds at Fidelity Fall Short of Rivals

Fidelity Investments
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Fidelity Investments

Fidelity Investments is the giant of "target date" mutual funds, one of thehottest ideas in 401(k) plans.

For its customers, the payoff has hardly been outsize.

Target date funds are supposed to make investing hassle-free — and safer — by automatically shifting from stocks to bonds as investors near retirement age. But new research shows that many Fidelity target date funds have routinely turned in worse returns in recent years than their biggest peers.

The Fidelity funds, it turns out, made smaller bets on stocks than their big competitors. That was a smart move in 2008, when stocks plunged.

Since then, however, the broad stock market has rallied, and the Fidelity funds missed out, relatively speaking. The performance was particularly bad during the last three months of 2012, when 13 out of Fidelity's 14 target date fund groups performed worse than at least 75 percent of their competitors, according to quarterly data that will be released Tuesday by Morningstar.

Investors have flocked to target date funds in part because fund companies aggressively market them as easy to use. But big investment companies have taken somewhat different approaches to managing these funds. Asset managers essentially disagree about one of the most basic questions in investing: how much risk should you take as you get older?

At T. Rowe Price and Vanguard, the other leading companies in this field, larger bets on stocks have helped target date funds outperform a majority of comparable funds over the last one, three and five years, according to a recent analysis done by the Center for Due Diligence. At Fidelity, the majority of target date funds have done worse over those periods. The three companies together control 76 percent of the $485 billion in target date funds.

The difference conflicts with the popular perception that the funds are homogeneous investment vehicles that require little oversight. Many companies offer their employees only one set of target date funds in 401(k) plans and use the funds offered by their retirement fund administrator. As one of the biggest such administrators, Fidelity has a significant edge in attracting money.

Industry experts warn against shifting savings into funds with the best recent record. But they say that employers should be more aware of the significant differences between the target date funds they offer their employees.

"Have companies evaluated the funds, or are they using them out of convenience?" said Phil Chiricotti, the president of the Center for Due Diligence. "Do you understand what you bought? The answer is probably no."

Mr. Chiricotti and other industry watchers say that in most cases any target date fund is a better option for investors than trying to manage their own portfolios and switching between stocks and bonds as time goes on. Target date funds also provide diversification, a proven strategy for improving long-term returns.

The low level of investor engagement required by target date funds is what has helped make them so popular since they were created in the 1990s. Retirement savers poured $55 billion of new investment into target date funds last year, a year in which billions of dollars were flowing out of normal stock mutual funds.

Still, investors appeared to be responding to Fidelity's lagging returns. Last year, the amount of money flowing into Fidelity's target date funds was significantly smaller than the amount going into funds run by Vanguard or T. Rowe Price.

Fidelity has defended its strategy. Derek Young, the president of Fidelity's Global Asset Allocation business, said that he was more interested in protecting savers from the "downside" of market turmoil than he was in capturing the "upside" of big market rallies.

"We are sensitive to making sure we're not overly aggressive," said Mr. Young.

On the other end of the spectrum, T. Rowe Price has been particularly eager to take on more market risk. This has helped nearly every single one of its target date funds perform better than 90 percent of their competitors over the last one, three and five years.

Critics said that could be leading investors to take too much risk too close to their retirement. But Wyatt Lee, a portfolio manager for T. Rowe Price Retirement Funds, said that he was more worried about an investor's running out of savings later in life, and was willing to increase the risk in his funds to decrease the chance of that happening.

For Fidelity, the underperformance is not only because of its risk profile. Morningstar analysts said that the Fidelity target date funds had suffered because they put much of their money into actively managed Fidelity mutual funds that did worse than their competitors. This not only decreased the returns offered by Fidelity's target date funds, it added more fees to the mix.

Vanguard benefited from investing all of the money in its target date funds into low-fee mutual funds that automatically track indexes.

Fidelity is taking steps to make up for its shortcomings. It introduced an index-based target date fund in 2009. In its older funds, Fidelity has put some money into a few Fidelity mutual funds it had not used in the past, that have had better performance records.

"We've long criticized them for not using their best managers," said Janet Yang, a Morningstar analyst. "It bodes well that they have added the new funds."