Investors expect their conservative target-date funds to protect their assets as they approach retirement. So with 2010 funds—the first group of target-date funds—approaching their end dates, it's surprising to learn how poorly these funds performed in 2008. Losses at the four largest 2010 funds in 2008 through mid-December ranged from 23% to 33%. If a fund loses 33% of its value, it will need a 50% gain just to regain lost ground. (For more information on the performance of 2010 funds, see "2010, A Fund Odyssey," November 2008.)

This grim news hasn't affected sales, however. According to Cerulli Associates, a Boston-based research firm, these funds captured almost $36 billion in new assets in the first three quarters of 2008; Cerulli projected year-end total AUM would reach $185 billion. By 2013, more than $1 trillion will be invested in target-date funds, Cerulli predicts.

This growth is due largely to the Pension Protection Act of 2006, which gave a green light to using target-date funds as a default investment choice (a qualified default investment alternative, or QDIA) in 401(k) and other defined contribution plans. Target-date funds made the QDIA list because Congress bought into the concept of an allocation "glidepath," from aggressive to conservative, in the years approaching retirement. Plan sponsors apparently share the enthusiasm for this strategy, as 67% of all target-date assets are held in defined contribution plans, Cerulli reports.

Despite the recent carnage, target-date funds are standing fast. "We're not changing our asset allocation," says Chris Sharpe, co-manager of Fidelity's target-date funds, voicing a view also expressed by other leading target-date funds.

Timing Game

Holding fast may be understandable for funds with a target date of 2030. With more than 20 years until retirement, 401(k) participants can buy stocks at depressed prices now and perhaps for years in the future. Judging by historic performance records, there's an excellent chance that equity markets will be sharply higher by the time today's thirty-and fortysomethings reach retirement.

For workers expecting to retire soon, though, target-date funds haven't met Congressional expectations. "An investor looking at a target-date fund for wealth preservation may have been disappointed," says Michael Herbst, an analyst at Morningstar.

Sponsors insist that target-date funds are not meant to mature at the expiration date, like a bond. "Fewer than 20% of our investors liquidate their funds at the target date," Sharpe says. "They'll need money for a retirement that might last 25 years or longer, and cutting down on equities probably will hurt them."

In fact, Sharpe says Fidelity's target-date funds raised their equity allocations by a few percentage points a few years ago and extended the roll-down from stocks to bonds. "We were not chasing returns when stocks were strong. We made the change in response to improvements in mortality. If people will be living longer, they should have more equities and more potential for greater long-term returns."

Indeed, some target-date fund sponsors go to great lengths to show that a fund's date is not the end of the line. T. Rowe Price's handout for its target-date funds includes a graphic showing standard asset allocations from 25 years before retirement (90% stocks) to 30 years after retirement (20%). "The target date is just a blip on the screen of a long-term strategy," says Christine Fahlund, senior financial planner at T. Rowe Price. "It's not meant to be an end point."

Staying the Course

As a result, sponsors of leading target-date funds say they're not making major changes in portfolio construction, even for near-dated funds. Vanguard is "staying the course," says Steve Utkus, head of the firm's Center for Retirement Research. "We're strategic investors, so we take a long-term view. Very few investors are pulling out of these funds, especially in 401(k) plans."

At T. Rowe Price, target-date funds are rebalancing, which means a shift from bonds to stocks. "We've increased equity allocations by two percentage points," says Ned Notzon, chairman of the firm's asset allocation committee. "If you're selling stocks now, you're locking in losses." Fahlund says this is important for retirees and near-retirees who have suffered steep losses in these funds. "You need equities to bring you back," she says.

Other fund sponsors say some tinkering is under way. Fidelity is placing more emphasis on "deliberative vehicles" dedicated to the firm's target-date funds, according to Sharpe. This may mean more managerial input and less reliance on existing Fidelity funds.

On the fixed-income side, the result might be more government holdings and fewer products with credit risk. In equities, Fidelity wants to avoid market-cap creep and sector bias. "With dedicated funds, we might be able to tone down return swings," Sharpe says.