Trying to Build a Better Retirement Fund

Pimco and Invesco use derivatives to protect target-date offerings | “Some people are losing sight of the risk-management goal”

Margaret Collins

Upward March


Target-date funds were designed to be a simple choice for retirement savers who don’t want to devise their own investment strategies or adjust them over time. The funds typically hold mostly stocks when an investor is younger, then shift to more conservative assets, such as bonds, as retirement approaches. In the financial meltdown of 2008, when stocks and bonds suffered sharp declines, that recipe didn’t offer much protection. Some target-date funds designed for those close to retirement lost as much as 41 percent that year while the Standard & Poor’s 500-stock index fell about 38 percent, according to Morningstar.

To address that problem, Invesco and Pacific Investment Management are adding derivatives and unconventional assets to their target funds. While the approach may cushion the funds in down markets, the strategy adds expenses and makes the funds harder to analyze for investors and employers who offer them in 401(k) plans. “Managers are looking to deliver strong returns with less volatility, and that’s why they’re looking to diversify” their investments, says Laura Lutton, an editorial director in the fund research group at Morningstar.

Target-date funds have been one of the industry’s bright spots. Total assets in the funds have swelled more than 380 percent since 2005, to about $343 billion as of September, according to the Investment Company Institute. One reason: The federal government endorsed them in the Pension Protection Act of 2006. Employers have since favored the funds when automatically enrolling workers in 401(k) plans, triggering an influx of money.

Since the 2008 debacle, many providers have diversified their holdings and added investments designed to protect against falling markets and inflation. JPMorgan Chase, AllianceBernstein, Northern Trust, State Street Global Advisors, and others now offer real estate investment trusts, commodities, or Treasury Inflation-Protected Securities (TIPS) as a hedge against rising prices. In the fourth quarter of 2011, Fidelity Investments also tacked on floating-rate debt and real estate debt as asset classes, says Joe Cullen, institutional portfolio manager at the company.

Invesco uses exchange-traded futures and some swaps on futures to invest in commodities such as oil and soy meal, says Scott Wolle, chief investment officer of Invesco Global Asset Allocation. It also employs derivatives to trade in six global equity markets and sovereign-bond markets, including Australia, Japan, and Germany. In 2011 the Invesco Balanced-Risk Retirement 2020 fund gained about 9.8 percent with dividends reinvested, compared with an industry average of –1.6 percent last year, according to Morningstar.

Pimco uses derivatives such as options and futures in its target-date funds “to hedge against severe market dislocations and shocks,” says John Miller, head of the company’s U.S. retirement business. The firm’s target-date fund for those retiring around 2020 has returned about 16 percent as of March 27 with dividends reinvested since its start in March 2008.

The big question — will the strategies protect investors long-term? — remains unanswered. Some in the industry warn that such alternate assets don’t always work to reduce losses. “Some people are losing sight of the risk-management goal by adding all these additional asset classes,” says James Lauder, chief executive officer of Global Index Advisors, whose Atlanta firm manages about $14 billion in target-date fund assets for Wells Fargo and State Street. “If you devastate their portfolios,” he says, the fact that you were hedged against inflation “doesn’t matter.”

The bottom line Pimco and Invesco are trying to avoid a repeat of 2008, when some target-date funds lost 41 percent as the S&P 500 fell 38 percent.


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