Target-date funds have been blossoming as a one-stop shopping investment vehicle to save for retirement or a child's education.
While their assets have hit $4-billion in Canada as investors gravitate to them because of their low-maintenance appeal or offer of a guaranteed amount at maturity, the funds have also run into growing pains.
Two fund families have capped investments after being forced to shift into bonds after last year's market collapse, while others are getting out of the niche. At least one fund is giving investors their money back well ahead of schedule.
Many of the funds that have run into headwinds are so-called guaranteed funds.
We didn't expect the catastrophic meltdown. — Jim Fraser, senior vice-president of marketing at Mackenzie
Products like Bank of Montreal's BMO LifeStage Plus, Mackenzie Financial Corp.'s Destination + and IA Clarington Inc.'s Target Click portfolios have been driving the growth in the sector by promising investors "downside risk protection but also potential for upside," said Investor Economics' Iassen Tonkovski.
If investors hold their funds to their maturity date, they will be guaranteed either the highest monthly or daily net asset value. This is done by investing in strip bonds early or late in their lifespan.
Last fall's market crash, however, forced all of Mackenzie's four Destination + funds, which were launched in January, 2008, to shift into strip bonds to be able to make good on their high-water mark.
Investors who were fully invested in equities with such target dates as 2020 and 2025 found themselves in all bonds, and would have to stick with this investment to get their fund's best return last year.
"We didn't expect the catastrophic meltdown," said Jim Fraser, senior vice-president of marketing at Mackenzie. "It doesn't make sense to market those funds now to new investors because all they would be buying is zero-coupon bonds."
We had the perfect storm of significant market volatility and much lower interest rates. — Mark Stewart, BMO Mutual Funds
Similarly, the BMO LifeStage Plus 2015 and 2020 portfolio shifted into all bonds last fall, and have also closed. Both Mackenzie and Bank of Montreal acknowledged that some investors in the capped funds have forsaken the guarantees and redeemed at a loss to invest elsewhere.
"We had the perfect storm of significant market volatility and much lower interest rates," said Mark Stewart, a BMO Mutual Funds executive. "But we still believe in the product."
Some BMO clients who redeemed at a loss have reinvested their remaining money into BMO's newly launched LifeStage Plus funds, with such maturity dates as 2017, 2022 and 2026, and it's because they still like the guaranteed-return feature, he said.
With some funds missing their mark, analysts question whether these investments - which automatically become more conservative as the target date nears - are the best savings strategy.
With their higher fees, they argue that investors can do a better job building their own portfolio with an adviser or by themselves through exchange-traded funds (ETFs).
"I am not a fan of these at all," says Dave Paterson, an independent fund analyst.
With the guarantee features and the wide range of asset mixes in the different funds with similar target dates, it "really reiterates the fact that, even though they are a 'simple investment,' they are still fairly complicated," he said.
Investors give up a lot of control with these funds, Mr. Paterson added. "The problem with any out-of-the box solution is that they are not overly flexible. It assumes everyone with the same target date is going to want the same asset mix or asset allocation."
If you haven't done your homework, you may actually end up having more market exposure than you actually think. — Dave Paterson, fund analyst
Fund analyst Peter Loach said target-date funds, which invest in other funds and/or offer guaranteed returns, are "loaded with fees" that can be a drag on returns. "You have to understand what you are buying," he warned.
While these funds have their skeptics, Toronto-based Investor Economics estimates they should hit $20-billion over the next decade after growing nearly threefold from $1.4-billion at the end of 2006.
Despite the size of the market, such firms as Russell Investments Canada Ltd. are actually withdrawing from the niche. It is winding up its LifePoints funds in November because it has been unable to attract sufficient assets.
