After one 2030 target-date fund lost 41% in 2008, legislators in Washington went up in arms against the fund category. One of the most controversial proposals would have limited equity exposure in such funds, but the industry fought back on the grounds the 40 Act gives asset managers leeway to determine asset allocation on their own.

A closer inspection by Morningstar [MORN] found that target-date funds have actually outperformed balanced offerings across the board in the past three years. The average 2035 fund lost 1.93%, while the average balanced fund lost 2.77%.

Further, Morningstar's “2010 Target-Date Series Industry Survey,” which analyzed the offerings of the 20 largest advisors, found that those companies that went ahead and answered calls to reduce equity exposure suffered steep losses in 2008.

Ironically, these “changes to the funds’ equity exposure could leave the industry open to charges that it’s fighting, [not riding] the market, and not positioning the funds correctly for the future,” said Laura Pavlenko Lutton, editorial director of the mutual fund research group at Morningstar. “Some funds that were aggressively positioned in 2008 were whipsawed when they turned conservative prior to the market rebound in 2009.”

“Target-date funds have been the subject of unprecedented regulatory, governmental and media criticism in the wake of 2008’s market slide, but that has not deterred millions of investors from making these funds the centerpiece of their retirement savings,” Lutton said.

“More than $45 billion in new cash flowed into these funds in 2009,” Lutton continued. “Target-date funds have become the retirement vehicle of a generation, and for good reason. The funds have structural advantages over traditional mutual funds, including generally lower costs and dynamic asset allocation that automatically grows more conservative as investors age.”

Morningstar also found that fund families have been lowering costs or introducing cheaper indexed series, and that fund complexes that populated their target-date funds with proprietary, rather than outside, funds showed no advantages in terms of costs or performance.

Areas for improvement, however, include far beter disclosures on the holdings and risk levels in various target-date funds, as well as the fact that too few portfolio managers have their own money invested in the funds they run.

Commenting on these findings, Lutton said: “It’s critical for individuals to easily understand their target-date fund’s goals, strategy and risks, and it’s important for fund managers to have some skin in the game. Many fund families still do not meet what we would consider to be basic levels of disclosure and manager investment.”

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