Target funds are funds-of-funds that work like this: If you plan to retire in 2025, you invest in a 2025 portfolio, and as you age, the fund gradually becomes less risky, mainly by subbing bonds and cash for stocks.
Now, with a larger investment palette, managers of these funds say they are able to enhance diversification, boost performance, and combat inflation without taking on additional risk. "We could put a kitchen sink in these funds," says Jonathan Shelon, co-manager of Fidelity Freedom funds, a series of target funds. "But you don't want to diversify for the sake of diversification."
In April, for instance, Fidelity Investments, which manages $50 billion of the $87 billion in target portfolios industrywide, added Fidelity Strategic Real Return fund (FSRRX
) to the Freedom funds. Strategic Real Return, whose goal is to beat inflation, invests in TIPS, commodity- linked notes, and REITs. Allocations among the Freedom funds range from 1% in the longest maturities to 7% in the soonest-to-mature.
Fund managers are putting more diverse assets into the target portfolios because there are more options available. REITs aren't new, but TIPS were introduced only about 10 years ago, and managers don't like to adopt new assets until they can see a track record. Still, a few are moving gingerly. At least nine fund companies use TIPS in target funds, and eight use REITs.NEXT FRONTIER
Barclays Global Investors, which manages $10 billion in target fund assets, offers both. In January, Barclays added a real estate and a TIPS index fund to its LifePath portfolios.
Real estate doesn't move in tandem with the stock market. That makes it valuable in a multi-asset portfolio, says analyst Greg Carlson at fundtracker Morningstar (MORN
). "It certainly doesn't hurt that real estate has performed very nicely over the past five years," Carlson notes. No fund company is allocating more than 10% of an underlying target-date fund to real estate investments; an allocation above 20% would raise red flags, Carlson says. The reason for adding TIPS is inflation protection: Their payouts, if held to maturity, increase with the consumer price index.
While firms are dabbling with emerging-market debt and preferred stocks, fund companies have stayed away from pure-play commodities investments. But commodities may be the next frontier. They intrigue Jeffrey Tyler, co-manager of American Century's Livestrong funds. "Commodities are a great uncorrelated asset class," he says. Tim Kohn, a defined-contribution specialist at Barclays, which also is one of the biggest money managers of exchange-traded funds, says he would like to see a commodities ETF in the LifePath funds.
Since target funds started incorporating new assets so recently, it's too soon to tell what effect they've had on performance. Then again, these funds are meant to be steady performers, not shooting stars. Says Carlson: "No one is going to get scared out of these funds because of the volatility." By Lauren Young