Large 401(k) providers like Fidelity are finding a wealth of asset-gathering success by selling target-date funds in retirement plans, but an executive at a much smaller investment firm says he is wary of a product that sounds too good to be true.
Marketed as a simple, "set-it-and-forget-it" retirement tool, the target-date product is a fund of funds that automatically manages and reallocates assets as an investor approaches retirement.
Investors put nearly $13 billion into target-date funds last year, doubling the pace of 2003, according to Financial Research Corp. in Boston. Fidelity Investments garnered $9 billion of assets with the Freedom Funds, its family of target-date funds. The family grew by 41% last year, to $31 billion.
John Sweeney, a senior vice president of mutual fund product management at Fidelity, said the product continues to gain popularity with investors and retirement plan sponsors. About 75% of sponsors that use Fidelity products offer the Freedom Funds, he said.
Mr. Sweeney said he expects the product, introduced by Fidelity in 1996, will continue to burgeon.
"One of the most important issues for retirement plan sponsors is to make sure their employees are correctly allocated through accumulation and distribution," Mr. Sweeney said. "This product accomplishes that."
Six hundred companies, including Fidelity through its 401(k) plan for its own employees, use the Freedom Funds as the default for people who fail to elect an investment option in their retirement plan.
Unified Trust, a Lexington, Ky., trust and investment management company with $850 million of assets under management, is cautious to the extent that it has launched another type of product to keep investors away from target-date funds.
Gregory Kasten, the company's president and chief executive officer, said target-date funds are a good tool for 401(k) participants in theory but that the rubber ultimately just does not meet the road. Target-date funds are costly, used incorrectly by investors, and lack the open architecture successful investment products boast, he said.
"Target-date funds are supposed to be a one-stop shop for retirement plan participants," he said, "but the problem is, as you study retirement plans, 90% of participants that have money in these funds use them incorrectly."
Mr. Kasten said that for target-date funds to work investors must use them as their only retirement solution but that most investors use them as just another in a menu of funds - creating diversification problems.
"The practical sense is, they are ineffective," Mr. Kasten said. "Investors are jumping in and out and looking at these products on a return basis. They are chasing performance."
The product is costly because many companies that offer it charge a fee equal to the sum of all the underlying mutual funds' up-front fees, plus a fee for the overlay manager, Mr. Kasten said, and in most cases the underlying funds are proprietary. Vanguard Group does not charge an overlay fee, however, he said.
Mr. Sweeney said Fidelity's Freedom Funds does charge an overlay fee but is competitively priced with other target-date funds. Most participants use it as the only product in their 401(k) plan or as the core product, he said.
Mr. Kasten said the flaw in target-date funds has less to do with the providers and more to do with customers who use them incorrectly. "We had a number of plans we had them in, but we ended up taking them out," he said.
Unified Trust has created a series of six "managed model" portfolios, however, he said, that look like target-date funds but have subtle differences intended to make them more effective. They allocate a participant's assets between equities and fixed-income securities in six steps - from 100% equity, to 80% equity, 60% equity, 60% fixed-income, 80% fixed-income, and 100% fixed-income as retirement approaches.
Unlike the target-date funds offered by companies like Fidelity, Mr. Kasten said, Unified Trust selects funds from different managers, does not charge an overlay fee, and permits only that product in a 401(k) account once the participant selects it.
"Every penny in their 401(k) is in that portfolio," Mr. Kasten said "This helps us avoid just being another choice."
He said 80% to 90% of Unified Trust's 401(k) plan participants use the managed model portfolios. The product, which was launched five years ago, has been an important contributor to growth. Unified Trust's assets under management grew 39% in 2003 and 24% last year, he said.
"This is a product that people want, and it is helping create growth for us that is beyond the industry," he said.
Mr. Kasten said he expects to grow twice as fast as the industry this year. Mr. Sweeney said Fidelity has started an adviser series in its target-date funds that has started to gain traction.
"It is our obligation to help employees to prepare for retirement," Mr. Sweeney said. "To help them do that is to make sure they are in the best investment product for them for the life of their savings."
