Target Maturity Funds Have Tough Second Quarter

In the U.S., employment growth slowed, first-quarter gross domestic product was revised downward, and corporate profits fell during the first quarter of 2012 for the first time since the last quarter of 2008. Eurozone concerns lingered, particularly on worries around Greece and Spain. These events contributed to a tough quarter for target maturity funds, which have exposure to equity and fixed-income asset classes domestically and globally. Non-U.S. equity was the biggest drag on target maturity performance, according to Ibbotson Associates’ Target Maturity Report for the second quarter.

Some of the survey’s key findings for the quarter include:

The average loss for target maturity funds was 2.8%, nearly identical to the performance of the S&P 500 and almost five percentage points lower than the Barclays U.S. Aggregate Bond Index. The poor performance was driven by the dismal performance of non-U.S. equities, which lost almost 7%.

12-month performance dropped into negative territory with the average target maturity fund losing 0.5%. This was also driven by the underperformance of non-U.S. equities, which lost more than 13% over the period.

Despite the poor performance of global markets, assets continued to flow into target maturity funds with the help of auto-enrollment and auto-escalation features. At the end of the second quarter, total assets in target maturity funds reached $431 billion.

After the first quarter’s average return of nearly 9%, target maturity fund performance took a step back with the average target maturity fund losing 2.8% in the second quarter. For the 12-month period, the average return dropped into negative territory with a 0.5% loss.

More typical, Ibbotson said, is for the average target maturity performance to fall between that of the S&P 500 and the Barclays U.S. Aggregate Bond Index as the funds are made up of a mix of equities and fixed income. But over the past quarter and 12-month period, the returns of target maturity funds have been lower due to non-U.S. equity exposure. Over the past year both U.S. equities and fixed income had fairly strong returns with the S&P 500 rising 5.5% and the Barclays U.S. Aggregate Bond Index up 7.5%. But target maturity fund diversification into non-U.S. equities dragged performance down below those levels.

In asset-class performance, equities took a drastic turn for the worse, detracting from performance in diversified strategies such as target maturity funds. After improved performance during the first quarter, non-U.S. equity markets led the decline during the second quarter as the worst-performing equity asset class. Emerging markets equity, which has historically been a highly volatile asset class, was the biggest loser with an 8.8% decline followed by developed non-U.S. equity with a 6.9% drop. In the U.S., the recent trend of growth outperforming value continued as did large-cap equity outperforming small-cap equity. Alternatives such as commodities also struggled during the quarter declining 4.6%.

The bright spot was U.S. real estate investment trusts (REITs), the only equity asset class to turn in not only positive results but an actually strong 4.0% return, rewarding those target maturity funds that allocated significant assets relative to peers.

Fixed income provided much more safety, with fixed-income asset classes ending the quarter with a positive return. Those asset classes with longer duration had the best performance as can be seen with TIPS and U.S. aggregate bonds relative to U.S. short-term bonds and cash. High-yield bonds, which exhibit a much higher correlation with equities than other fixed-income asset classes, did provide a respectable 1.8% increase.

The quarter’s tumultuous performance didn’t have much of an effect on flows into target maturity funds. Flows held up with a very strong $13.9 billion inflow. Fidelity, Vanguard and T. Rowe Price continued to garner the majority of flows, capturing 73% of net flows. Other target maturity fund providers that saw large inflows were J.P. Morgan, John Hancock, TIAA-CREF and BlackRock. There was some contraction in the industry this quarter as well, with three fund providers deciding to close their target maturity series (Oppenheimer, Goldman Sachs and Columbia).

Despite the nearly 3% loss on average, target maturity funds continue to see total assets climb to all-time highs. As of the end of Q2, total assets in target maturity funds were nearly $431.5 billion, a slight 0.6% increase from a quarter ago. Fidelity, Vanguard and T. Rowe Price hold around 75% of total assets, but other fund families continue to make headway in this space. PIMCO again saw a significant increase with assets in its series rising by 12.8% to more than $298 million. Although PIMCO’s total assets are a small percentage of the industry’s total, the series has more than tripled over the past three quarters. Other target maturity fund providers that saw significant increases during the period include BlackRock, Invesco, and JP Morgan with increases of 9.3%, 8.0%, and 7.0%, respectively.

Ibbotson Associates, an independent provider of asset-allocation, manager selection and portfolio construction services, is part of the Morningstar Investment Management division of Morningstar Inc.

The Ibbotson Target Maturity Report is available here. 

Jill Cornfield